The New Hedge Funds: Lower Returns, Less Risk

Hedge funds are making a comeback, but don’t count on the market-stomping returns that were synonymous with hedge funds prior to the economic meltdown. With lower returns and less risk, the new hedge funds may fill a new role in many portfolios.

The year 2008 marked the peak of the financial crisis for hedge funds, with the average fund losing 19%. A combination of losses, client withdrawals, and liquidation of certain funds led to a nearly twenty-five percent decrease in the size of the hedge fund industry.

Hedge funds are back in the black in 2011, but are no longer beating the markets. According to Hedge Fund Research, the average yearly fund earnings were 20% and 10.3% in 2009 and 2010, respectively. These numbers were far below the S&P 500 levels of 26.5% and 15.1% for the same years.

Although returns aren’t spectacular, the industry’s assets have slowly been making their way back to pre-financial crisis levels. Last year, hedge funds brought in $55.5 billion in net new money. With total assets are approaching $2 trillion, hedge fund assets are estimated to exceed pre-crisis levels by year’s end.

The fact that the market is gaining steam doesn’t necessarily mean profiting from hedge funds will be as easy as it was during pre-crisis levels. Stifling new regulations stemming from the financial crisis are increasing expenses, with most fund managers now being required to register with the SEC and funds being required to report extensive information to the SEC. Also, post-crisis practices at funds are decreasing hedge fund risk at the expense of returns.

Prior to the financial crisis, hedge funds often were using extreme leverage to multiply returns. While this dramatically increased the hedge funds’ returns, it also increased their risk. Once the financial crisis hit, many funds collapsed under the weight of their debt, leaving investors empty handed.

Although returns at hedge funds are no longer enticing to some investors, private funds are pulling in assets at a record rate, signaling their viability in the still nascent recovery.

 For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s partner, AdvisorFX, for a free trial.

See also The Law Professor's blog at AdvisorFYI.

Reprints Discuss this story
This is where the comments go.