HFR, the hedge fund research firm, announced March 18 that 904 hedge funds were liquidated in 2013, a three-year high, while launches of new funds (1,060) fell to their lowest level since 2010, when 935 funds were launched.
Those numbers, included in the HFR Market Microstructure Industry Report, were posted despite hedge funds ending the year with a record $2.62 trillion in assets. HFR also reported that fees were nearly flat in 2013, with the average management fee at 1.54% for the year and an average incentive fee of 18.27%; funds launched in 2013 had an average management fee of 1.42% and an average incentive fee of 16.99%.
What did investors get for those fees? It all depended in which funds you were invested: The top decile of hedge funds in HR’s HFRI Hedge Fund Indices benchmark gained 41.6% in 2013, while the lowest decile declined 18.9%, leading to the widest dispersion between the top and bottom performance deciles since 2009.
A series of pieces by Dan McCrum on the Financial Times FT Alphaville site (free registration required for access), cleverly called No Alternative: The Zombie Hedge Fund Industry Series, put these numbers into context. In his posting on March 25, McCrum pointed out that those 904 liquidated funds accounted for 10% of the more than 8,000 hedge funds that HFR currently tracks, and that “half of all individual hedge funds have closed in the last five years.” McCrum goes on to argue that “in the last five years 4,318 hedge funds have closed. If we add on the 1,471 zombies added to the horde in 2008, that is 5,789 dead funds, set against the 7,634 live hedge funds and 2,462 fund of funds that existed at the end of 2007.” (Just one of the issues with (private) hedge funds is that fund managers don't all choose to report to every hedge fund database.)
Why should you care? McCrum says that the number of zombie hedge funds “will live on in the databases of hedge fund returns,” but the mortality rate of hedge funds “is a salient fact that seems to escape the promotion of hedge funds as an asset class, a diversifier or a handy set of uncorrelated investment returns.”
Many advisors are more comfortable investing in mutual funds on behalf of their clients rather than hedge funds or other alternatives for a variety of reasons, including lower costs, leverage controls, more liquidity and transparency. But what about the rise of mutual funds that follow hedge-fund like strategies? Morningstar reported in January that in 2013, net flows of assets into alternative mutual funds rose 43.9%, or $40.21 billion, but MainStay Marketfield Fund captured a third of the flows, $13.36 billion. New York Life Investment Management’s Marketfield (MFADX) is a long/short mutual fund. Total assets in the alternative category reached $132 billion at year-end 2013, an amount dwarfed by the assets in every other category save one (commodities).
The performance figures of defunct investing vehicles “live on,” notes McCrum, and that includes mutual funds. In a blog posting on ThinkAdvisor, Dan Kern of Advisor Partners explored research he conducted on mutual fund closings and why those closings are important to advisors and their clients. Kern’s research found that of all the mutual funds in existence on Jan. 1, 1995, less than 40% still existed in 2013: “The remaining funds were either closed or merged into other funds.” Looking at another time period—the 10 years from the end of 2002 to the end of 2012, the results were similar: “Over five years, nearly one-third of the funds had been closed or merged into other funds; after 10 years, nearly half had been closed or merged.” Kern dryly points out that closures or mergers “are rarely positive events for investors,” forcing a new investment decision, which may occur at an inopportune time for the investor, and may also lead to “adverse consequences” such as a taxable event.
In a blog posting on ThinkAdvisor, Bob Clark spoke to Kern and Tim McCarthy, author of the new book “The Safe Investor,” for whom Kern conducted the research, about why advisors should care about fund closings. Among the reasons:
1) It costs more money to wind down mutual fund holdings.
2) The fund managers are selling at the wrong time, forced to sell assets to pay off investors.
3) Those managers are moving out of the market and into cash, losing the benefits of any good holdings they had.
4) Those managers tend to lose focus once they realize their fund is going to be closed down.
But he closes his piece by detecting a silver lining for advisors. Yes, closings can “hurt portfolio performance,” Clark writes, but “detecting these closings early creates yet another way they can benefit their clients.