Time to trim back the hedge funds
October 10, 2013 Leave a comment
October 8, 2013 6:12 pm
Time to trim back the hedge funds
Thanks to institutional interest, the sector is too big
Astriking feature of the post-crisis period has been the resilience of the hedge fund industry. In spite of their exorbitant fee structure and less than stellar performance – the average fund has returned just 4.5 per cent per annum since 2009, according to Hedge Fund Research – these investment vehicles continue remorselessly to expand. They now boast some $2.4tn under management, more than on the eve of the crisis six years ago.While some of this is due to investment performance, part has also come from investors pouring in new money. This has not come, it should be noted, from wealthy retail investors, the sector’s traditional mainstay. They have been pulling back. Instead, the baton has been taken up by the pension funds. Driven by the need to redeem costly past promises made to beneficiaries, institutions now account for about 60 per cent of hedge fund assets, up from less than half before the crisis.
There are signs that the hedge fund industry is, for all its proclaimed brainpower, struggling to eke returns from the money at its disposal. DE Shaw, which has just closed its doors to new investors amid falling returns, is just the latest to admit that it cannot keep growing. Other well-known firms, such as Seth Klarman’s Baupost and Louis Bacon’s Moore Capital, have been handing back capital.
Hedge funds may blame the inclement environment, but scale is also a factor. As the sector grows, it is harder for funds to devise distinctive strategies. Managers struggle to trade in and out of markets without moving prices against themselves. Hedge funds may still account for less than 10 per cent of investment funds worldwide, but they still make up a far larger proportion of trading on UK and US stock exchanges. This means the industry is increasingly engaged in a zero-sum game, in which one fund’s profit is another’s loss. Given their high fees and expenses, the majority are mathematically more likely to disappoint.
The hedge fund industry is not genetically coded to address this problem. While star funds such as Shaw and Baupost have the confidence to limit their size, the lucrative fee structure encourages many managers to gather funds regardless of whether they can find a profitable use for them. All the more reason then for pension funds to be wary of hedge fund promises. Shovelling ever more money at the sector looks like a recipe for disappointment. This prospect should worry not only the trustees but their beneficiaries too.
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