November 13, 2008

Hedge funds hitting bottom?

Hedge funds are losing steam, according to Morningstar research. Nearly half of all financial advisors who work with wealthy clients say they expect hedge funds to become somewhat less or much less important in clients' portfolios in the next five years.

The average hedge fund is down about 20 percent this year, and more than half of polled advisors and institutional investors cite lack of liquidity as a top reason for their hesitation in selecting hedge funds. They also worry about hedge funds' lack of transparency and high fees where investors pay both a management fee and performance fee.

But are hedge funds really headed for collapse? Barton Biggs, managing director of Traxis Partners, doesn't think so. "I run a hedge fund, so I am hardly an unbiased observer," Biggs writes for Fortune. However, he says, "nobody, and I mean nobody, really knows what hedge fund liquidity is or what redemptions are or will be... the worry is that a tsunami of redemptions from disillusioned investors will force a deluge of hedge fund selling that will depress markets further. I don't see that happening."

Why? "For one thing, the panic has abated, and since most funds have losses to make up before they can begin to earn their performance fee again, investors who redeem now are forgoing a free ride," Biggs says. "Another reason is that so-called long-only managers (mutual funds, investment counselors, traditional portfolios) have done even worse this year. So where are the redeemers going to put their money?"

Most of hedge fund money is in big, multi-strategy funds run by "the best and the brightest." Still, Biggs predicts several thousand smaller hedge funds will go out of business, because of either poor performance or lack of scale.
"Based on what I see and hear, $350 billion to $420 billion will be withdrawn by the middle of next year," Biggs continues. "There is about $250 billion to go... That's not a huge amount, but what the bears are terribly worried about is that presumably this money is leveraged, and so to raise the cash, hedge funds will have to sell two to three times that much."

"The bottom of a bear market by definition has to be the point of maximum bearishness, and I think we're there. For the market to go up, the news doesn't have to be good. It just has to be less bad than what has already been discounted."

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