Thursday, October 05, 2006

Hedge fund problems...

Weak Results Dim Hedge Funds’ Luster

For years now, Hedge Funds have been the darlings of Wall Street. Hedge funds are sophisiticated investments for institutions like pension funds and endowments and the wealthy. They are currently unregulated by the SEC because they are only open to a tiny minority of investors who: a) have a high level of sophistication and intelligence about investments, and b) have very large amounts of money to invest. (Thus, the "average" investor in a Hedge Fund may well be institutions like pensions and endowments mentioned above.) Part of the idea of Hedge Funds are they since they are not regulated, they do not carry the administrative costs of other investments, therefore they should consistently out-perform traditional stocks and mutual funds.

The SEC has in the past tried to get some control over these investment instruments, but have been halted in their attempts. But, as the article linked above discusses, the performance of some of the funds has not been stellar, and may provide an opportunity for the SEC to get back involved.
Recently, a well-regarded fund, Amaranth Advisors of Greenwich, Conn., made a wrong-way bet in the energy markets and lost more than $6 billion in a week. It will dispose of its remaining assets. Even the flagship hedge fund run by Goldman Sachs, whose trading prowess has few peers on Wall Street, fell 10 percent in August. A fund at Vega Asset Management, once among the 10 largest hedge funds in the world, fell more than 11.5 percent in September, leaving it down 17.5 percent for the year. Its assets, which once topped $12 billion, are now $2 billion to $3 billion, a person close to the fund said.

Returns for many hedge funds, which are supposed to be the market beaters, have paled in comparison with stocks. Hedge Fund Research’s weighted composite index is up 7.23 percent through September, according to a preliminary estimate, compared with the Standard & Poor’s 500-stock index, which, with dividends, has a total return of 12.4 percent over the same period.
The rise of hedge funds’ fame and fortune happened quickly. In 2000, the stock market began to slide, and almost overnight, a band of obscure money managers became the new millennium’s masters of the universe. Soon, huge buckets of money rained on these stars — $99 billion flooded into hedge funds in 2002, according to Hedge Fund Research. Since the beginning of 2001, nearly 7,000 hedge funds have been started.

With eye-popping compensation — the top manager took home $1.5 billion last year — hedge-fund performance, and the pay derived from it, redefined everything from job prestige on Wall Street to the price for art and real estate.

So while there has been nothing like a sweeping shakeout in the business or a market crisis like the near collapse of Long-Term Capital Management in 1998, some hedge funds, including some of the high-profile “safe” names, have failed to show any Midas-like magic.

Many of the big-name debuts of 2004, 2005 and even 2006 have produced lackluster results.
Hedge funds are Darwinian by nature: when returns are good, money flows in and when they are bad, investors scramble to get their money out as soon as possible.

So the spigot of new money into hedge funds has run hot and cold. After tapering off in 2005, with $46.9 billion flowing in, there has been a revival this year, with more than $66 billion poured into hedge funds in the first half of 2006 alone. That flood of money is not likely to end even amid the recent stumbles by hedge funds.
Pension funds, seeking to make up for years of being underfunded, have
increasingly turned to hedge funds. Many funds that cater to such institutions boast they can deliver consistent medium-range returns — 8 to 12 percent — that permit institutions to better manage their liabilities.

And endowments, which were among the earliest adopters of hedge fund investing, do not appear to be backing away.
Indeed, the changes that are likely to come in the wake of Amaranth will be in the form of increased vigilance by investors. Managers of funds of funds and consultants say investors may now temporarily delay their investments in hedge funds as they try to negotiate better terms to redeem their funds in the case of a crisis. And there may be calls from investors for greater disclosure, especially regarding how the funds are using leverage and derivatives.
In days when Hedge Funds are high-flying, it makes sense that it would be difficult for the SEC to be able to garner support for registration and disclosure within such funds. But, when performance is not so great - and especially when funds are losing $6BB in a week - the environment may be better to put some sort of rational registration requirements on the funds.

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