FT.Com: Hedge Fund Industry Lost 10% of Assets in December

Much like George Costanza (of Seinfeld fame), the hedge fund industry is facing some horrific shrinkage. [if you are not a Seinfeld fan, I realize that made little sense]

I started noting the danger of hedge fund liquidations in early September, right before the implosion era of Sep - Nov 2008.

Now one of the worries I am hinting at here today is what happens if multiple hedge funds (who are paid 2% of assets plus 20% of profits in most cases) simply give up in the fourth quarter and purposefully go out of business? That in itself could cause major selloffs in the market. Why would they go out of business on purpose? Because they don't get paid that 20% until they make their shareholders whole. So for example if they are down 15% this year - and someone invested $1M and was down to $850K, if next year they make 10% and get that account back to $935K they don't make that 20% fee next year. They have to get back to $1 million before they start making the 20% again. So why bother? Just shut the fund down, return the money to shareholders - sit on your rear for 6 months then announce your "starting anew!" raise a whole bunch of capital and you have a clean slate and can begin making your 20% of profits again. And since "savvy" investors seem to go to the same well over and over - I guess it works.

But what does that mean for us? If... and it's a big if... a lot of hedge funds close up shop in the coming few months their positions must be unwound. And unwound with leverage.... meaning indiscriminate selling. And in a globe that is deleveraging that is right now, something that could be quite nasty.

Should have listened to my leanings in retrospect... even if it wasn't on purpose; a lot of funds hit the exit sign. Now we have data showing just how bad it is out there - 10% of all hedge fund assets were extracted in December 2008; mind boggling. 10% shrinkage in 30 days - and that is with some of the biggest funds in the industry putting up "gates" (i.e. not allowing investors to take money out) As we noted in November, even the hedge funds doing well were in some cases seeing redemptions [Nov 6: Even Hedge Funds Doing Well are Facing Redemptions] In it's entirety the hedge fund world is down almost 50% from it's high (part of that is performance, part of that is redemption) - and now sits near $1 Trillion.

With the fee structure in place it's going to be a rough 2009 unless the hedgies can rebound quick - until their partners are made whole, conceptually they should make zero performance fees. Well... more money for me (ahem).

• Investors pulled close to a net $150bn from hedge funds last month in spite of moves by dozens of funds to halt or suspend redemptions. The record December figure, equivalent to about 10 per cent of industry assets, extends the run of outflows to four consecutive months and has increased the total net outflow for 2008 to $200bn.
• The size of the once lucrative industry has almost halved in the past year, to $1,000bn under management, according to data from TrimTabs Investment Research and Barclay Hedge.
• "We expected December hedge fund redemptions to be significant, but the results are still surprising . . . twice the peak equity mutual fund outflows in September at $72bn," he said. (remember, they say it's the retail investor who flees the market - you can see institutions pulled twice as much in December what the individual pulled in September)
• "Approximately two-thirds of industry revenues comes from performance fees and we estimate that 81 per cent of hedge funds were underwater [reported negative returns] last year . . . Managers have half the assets to work with and remaining assets need to fully recover prior losses before they can earn performance fees."
• Tremont, Tudor Investments, Citadel, Highbridge, Farallon, GLG and Drake are among the hedge funds and funds of funds that have halted, restricted or suspended redemptions.
• The size of the industry has fallen because of performance losses as well as investor redemptions. The average fund lost 21.7 per cent in 2008, according to Morningstar 1000 index. That is based on the 1,000 largest funds, which account for 90 per cent of industry assets.

[Apr 8: Hedge Fund Manager - Good Work if you can Get It]
[Jul 12: Some More Hedge Funds Biting the Dust]
[Aug 23: NYT - Running a Hedge Fund is Harder than it Looks on TV]
[Sep 2: Ospraie Fund to Close]
[Sep 3: Hedge Funds Get Rattled as Investors Seek Exits]
[Sep 23: Fee Slump Hits Hedge Funds]
[Oct 3: Hedge Funds Have Worst Month on Record]