Hedge Fund Assets May Fall by $450 Billion This Year (Update1)

BLUE CROWN FUTURES

By Saijel Kishan

Jan. 23 (Bloomberg) -- Hedge funds lost more money in 2008 than any year on record. It may get worse in 2009, forcing fund managers to overhaul investment strategies, reduce fees and make it easier for clients to withdraw cash.

The $1.2 trillion industry may shed as much as $450 billion in assets, or 37 percent, through market losses and client withdrawals this year, according to Morgan Stanley analyst Huw van Steenis in London. That’s on top of the $600 billion that disappeared last year and would leave hedge funds with $750 billion, the lowest since 2002.

“It’s hard not to be bearish in this environment,” van Steenis said in a telephone interview.

Investment returns fell an average of 18 percent last year, according to data compiled by Hedge Fund Research Inc., the most since the Chicago firm began tracking the industry. While that beat the 38.5 percent loss by the Standard & Poor’s 500 Index, many investors were angered when fund managers limited or froze withdrawals. Funds will have to reduce fees and loosen redemption rules to win back client confidence, said Craig Lilly, an attorney at Washington-based Squire, Sanders & Dempsey LLP.

“They will have to unilaterally cut their management fees in order to ensure the flow of capital from investors,” he said.

At least 20 percent of hedge-fund assets were subject to redemption restrictions last year, according to Peter Douglas, principal of Singapore-based consulting firm GFIA Pte.

Changes Underway

Some firms are already making changes. James Simons, who runs Renaissance Technologies Corp. in East Setauket, New York, told investors he won’t charge fees on the Renaissance Institutional Futures Funds in 2009. Cerberus Capital Management LP told clients last month it would waive 60 percent of the incentive fee on Cerberus Partners LP for a year after losses are recouped.

Investors are increasingly seeking to establish separately managed accounts, which mirror the investments of their managers’ hedge funds while providing more disclosure on assets and easier withdrawals, according to Simon Hookway, chief executive officer of MSS Capital Ltd. in London.

Hookway’s firm has formed a joint venture with hedge-fund adviser IGS Group, also based in London, to help investors set the accounts. Unlike hedge funds, managed accounts allow an investor to keep money separate from other investors and to make withdrawals at will.

Power Shift

“The whole basis of the industry has gone from managers having the overriding power to investors having overriding power,” Hookway said.

Managers also will dump illiquid assets that have killed returns and prompted the redemption surge, said Rishi Narang, founder of Telesis Capital LLC, a Los Angeles-based investor in hedge funds.

Tudor Investment Corp., the Greenwich-based firm run by Paul Tudor Jones, told clients in November it planned to sell off hard-to-sell investments, mostly corporate bonds and loans from emerging markets, after segregating them into a separate account. Ellington Management Group LLC of Old Greenwich, Connecticut, plans to follow a similar strategy, people familiar with the matter said in December.

“Hedge funds need to rid themselves of the garbage in their books by selling assets such as private equity and real estate,” Narang said.

Emphasis on Liquidity

As investors pull money from hedge funds, some are looking to managers who are able to sell securities quickly, enabling them to return money at short notice.

For that reason, Altedge Capital Ltd. in London may allocate more money to macro hedge funds, commodity trading advisers and funds that bet on the direction of equity markets.

“Liquidity is paramount at the moment,” said Cem Habib, a portfolio manager at Altedge, which invests about $350 million in hedge funds.

Macro funds, which typically invest in highly liquid markets such as currencies and bonds, returned 5.6 percent last year, according to Hedge Fund Research.

“The stars appear to be aligning for macro,” said Joe Paul, a director at Corazon Capital, a Channel Islands-based investor with about $1 billion.

Commodities Defense

Commodity trading advisers, which rely on computers to decide when to buy and sell securities, returned 13.9 percent last year, according to Fairfield, Iowa-based BarclayHedge CTA Index. Investors in CTAs normally are able to take their money out on a monthly basis, while some hedge funds lock investors in for as long as two years.

“We are looking at them not because of their returns but because they are a defensive play,” said George Chacko, chief investment officer in New York for Auda International LP, which oversees $5 billion. “Such investments allow us to stay liquid, and that’s important in this environment.”

The Standard & Poor’s 500 Index has slumped 8.4 percent this month while U.S. Treasuries have declined by 1.5 percent, according to Merrill Lynch & Co. indexes. Commodities, as measured by the UBS Bloomberg Constant Maturity Commodity Index, have declined 4 percent.

“Financial dislocation is likely to persist across many asset classes and geographies for some time,” New York-based Perry Capital LLC, which manages $8.3 billion, said in a Jan. 20 letter to investors. “We believe we are entering a period with an abundance of mispriced securities.” The firm’s Perry Partners International fund lost about 26 percent last year, according to the letter.

Slow Recovery

The average hedge fund has gained 0.84 percent so far in 2009 as measured by the HFRX Global Index, while the S&P 500 is down 8.3 percent, including reinvested dividends.

Citadel Investment Group LLC in Chicago has returned 6 percent this month through Jan. 13, according to investors. Waterstone Capital Management LP of Plymouth, Minnesota, has gained 10 percent through Jan. 16, according to a person familiar with the firm. Cantillon Capital Management LLC, a $4.5 billion firm in New York, returned 9 percent this month through Jan. 19 from its European fund, according to a person familiar with the firm.

The industry may be marked by “big winners, more failures, and slow recovery,” in 2009, Sean Simon, chief executive officer of Ivy Asset Management LLC, a Jericho, New York-based firm that invests $7.2 billion in hedge funds, said in a Jan. 15 letter to clients.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net;

Last Updated: January 23, 2009 14:54 EST