Hedge funds grew in popularity in the years after the Enron Scandal (2002) raising record amounts of capital and all purporting to have that special trading methodology or investment discipline that would score higher than average returns based on their posted or stated benchmark indicator. Endowments, insurance companies, institutions, municipalities were all clamoring to make better returns for their respective constituents. Money needed to be deployed because at the time idle money was dead money. During this meteoric rise into the trillions of dollars the hottest vehicles being created were the fund of funds which specialized in key areas of hedge fund managers specializing on the nature of the fund of funds “proprietary” diligence methodology. Times were good and the market was moving ever higher. The short funds were the most at risk and the hardest to raise capital for.
Between 2006 and 2007 there was a record number of hedge funds created raising a record amount of capital. New strategies were being created almost weekly and the alternative class of investment, where hedge funds were classed, were now a mainstream investment vehicle. This is one of the reasons that Madoff was so insanely popular and the consistency of his returns, unfortunately were all lies. Credit was plentiful and leverage was running rampant all on the basis of the increasing markets or , in essence, the greater fool theory.
Those were the good times and now the toll must be paid for all this capital that has been raised with these new and follow on hedge fund strategies. Liquidity has completely dried up, leverage is currently nonexistent and any flaw in these hedge fund strategies is now being exposed by these extreme market conditions. By street estimates the reduction in the global hedge fund market in both assets and number of actual hedge funds is believed that it will drop by almost 75% from the high. That is a trillion dollars of wealth that has potentially evaporated. The outlook is only decent for the best of breed funds. All the hedge funds whose strategies were only marginal are either gone or going. The main reason for the volume of these closures is the managers’ high water mark that all funds have. There is absolutely no way that these managers will see any upside from their failed strategies and thus it is better to walk away and regroup to either start another strategy, work for someone else or try their hand at investment banking. A first time fund has absolutely no business in trying to raise a new fund.
This market has crippled the hedge fund business which has a ripple effect. The trickle down causes trading volume at these bulge bracket brokerage firms to dry up, it effects the research arms of all the brokerage firms, it also dries up all the administrators fees not to mention the auditing firms and of course the law firms. This is a massive crisis that is not going to improve for quite some time. Any hedge fund managers still in business today are just trying to win the battle of attrition, which is no easy task.
3 responses so far ↓
1 Maurice Heffernan // Jan 23, 2009 at 9:36 pm
I would say 1 trillion in wealth transfer, not losses?
For every losser, there is a winner somewhere?
Whos the winner?
2 Hedge Fund Lawyer // Jan 25, 2009 at 6:28 pm
While many hedge funds are going out of business, there are still many managers who are throwing their hats into the ring. With the massive layoffs from wall street in the last year, it is not a surprise to see many of these investment professionals reinventing themselves as managers. Unfortunately, the market turmoil has led to increased calls for regulation of the hedge fund industry. Both Shapiro and Geithner have stated a desire to see more hedge fund regulations. While regulation (and registration) is not the end of the world, it will increase costs for a hedge fund start up.
3 Senthil // Jan 28, 2009 at 11:30 am
Dec 2008 is more or less the bottom and from Jan 2009 onwards it should all be up and up. If the hedge funds always stick to the basic common sense approach of not becoming too greedy and leveraged, I think they would prove to be the catalyst for the much awaited recovery. And this type of data are really feels welcoming.
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