Hedge Funds Get Clipped
Slim gains and scandals turn off investors
Think hedge funds mint money? Consider this: The Standard & Poor's hedge fund index posted gains of just over 2.4 percent in 2005--after meager gains of 3.6 percent in 2004--or about half the performance of the S&P 500.
That track record hasn't hurt the earnings of the average hedge fund manager, who took home about $1.2 million in 2004. But with the number of hedge funds--thinly regulated investment pools for the well-to-do--having mushroomed from a few hundred to more than 8,000 worldwide, with combined assets now around the $1 trillion mark, many investors are finding that storied hedge fund edge elusive. It's pretty hard, after all, to make the case that all 8,000 funds are being run by the best and the brightest. And in such a crowded field, many of the tactics that have made hedge funds so profitable in the past are oversubscribed.
Compounding such troubles is the fact that even high-profile funds have gotten caught up in legal and regulatory probes. Some pension funds are grumbling about the high fees that funds charge. And new research suggests fund returns were never quite so good as they first appeared. It's enough to leave some former hedge fund bulls to conclude that the party's over--for good. "Our day has come and gone," complains Joseph Aaron, whose California investment firm Wood, Hat & Silver has put money in hedge funds. "There's no edge left. The returns are just not there, and they aren't coming back."
In the dark. Most retail investors have only a vague idea of what hedge funds do to make money, or why hedge fund managers are able to charge fees that would be seen as obscene in any mutual fund. What they know is that hedge funds are hot and that they wield enormous power over the financial markets and the companies whose stocks they invest in.
They aren't totally off the mark. But the general rule of thumb is that hedge fund managers make sizable salaries by pledging to make money for their investors even when the stock market is tanking and the bond market is in the doldrums. They promise an absolute return and don't mind betting against the stock market, leveraging investor assets, or delving into all sorts of esoteric derivatives and volatile markets to do so. And over the past few years, at least until recently, many hedge funds have done well by the exclusive investors who often plop down minimum investments of $250,000 to $1 million to fund these financial excursions. Many received high double-digit returns.
Some of the old guard may continue to do well by their investors. But Aaron, who is pulling back from the sector, is not the only hedge fund watcher to be concerned that many others won't. Hedge fund inflows have dropped to about half the level of 2004. Withdrawals have also risen, as have the number of funds not reporting their results in 2005. And more bad news could be on the way.
William Wechsler, a vice president with financial services consultants Greenwich Associates, points out that hedge funds have flourished in a protracted investment environment where investors were confronted by both low interest rates and sluggish equity markets. "But that is a very unusual set of circumstances," he says.
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