The passing of the hedge fund industry’s annus horribilis has brought little cheer, with 2009 heaping more pain on battered players. Double-digit performance losses and massive client capital redemptions have seen total industry assets shrink from a peak of $1930bn (€1442bn) at the end of June 2008 to $1330bn at the end of the first quarter of 2009. Although capital redemptions have slowed, total hedge fund assets are forecast to slide further, to $1,000bn by the end of this year.
Hedge funds continued to haemorrhage capital in the first quarter of 2009, as investors redeemed nearly $104bn or 7.4 per cent of industry assets, according to data-provider Hedge Fund Research.
Funds-of-hedge funds suffered the greatest capital withdrawals in the industry - some $85bn in the first quarter. This exceeded the fourth quarter 2008 redemption total of $50bn.
These vehicles, favoured by small-to medium-sized pension funds, have been cast as the bête noire of the hedge fund world, blamed by consultants and peers alike for bad management and poor decision-making, which served to destroy investor trust not only in their own operations, but in the industry as a whole.
Nigel Blanshard, principal of funds-of-hedge funds outfit, Culross Global Management, contends that many funds-of-hedge funds were guilty of three sins: liquidity mismatching; mismanagement of their currency hedging operations and “acute” performance failure.
“For years we have argued that the liquidity mismatching has been prompted by asset-gathering motives and it is simply not in the interest of clients to do that. But these funds-of-funds took the view that the larger they became, the more advantageous the pool of assets would be to provide liquidity, which turned out to be sheer nonsense.”
The second problem, he says, was that in 2008 funds-of-hedge funds “grossly mismanaged” their currency hedging. He accuses them of failing to look forward and comprehend that in the event of the dollar rising rather than falling in value, their FX hedging would cost them money and drain liquidity.
“Many funds-of-hedge funds had no liquidity, ie no cash. They had not planned for the eventuality of the dollar rising in value and when it happened, they found themselves unable to access liquidity quickly enough to deal with the problem, because almost certainly they will have been rolling one-month hedgers and didn’t have sufficient one-month liquidity in their portfolios.”
Third, Mr Blanshard maintains that poor manager selection and portfolio construction work contributed in some cases to acute performance failure.
“I think in that respect they failed to live up to the guidance they had given to their clients about the fund-of-hedge fund being an absolute return strategy.”
He maintains that the “propaganda” about manager selection and monitoring put out by many funds-of-hedge funds “does not square with reality”.
For instance, he says meeting managers face-to-face is regarded as central to the manager selection process.
“There is not a person on the planet who would hire a nanny to look after their children without first meeting the candidate in question. And yet there are on record some very big funds-of-hedge funds that revealed they had not met all of their managers face-to-face. One very big European fund-of-hedge funds said that one of the changes in process that they are going to implement is to meet the manager. This is a truly shattering statement, which left us speechless.”
Another reason, he contends, for the poor performance of the asset management and investment banking industries generally, is the willingness of practitioners to “fool themselves” with the statistics they rely on.
Mr Blanshard believes that some funds-of-hedge funds managers compounded their performance problems by employing fixed levels of leverage, which they failed to monitor and adjust as circumstances changed.
“Once the level of leverage is fixed, the risk committee are not asking themselves whether continuing that is an appropriate thing to do or not. They just become complacent. And of course, the leverage facility was cut or withdrawn at exactly the same time that the funds-of-hedge funds suffered the liquidity mismatch and at exactly the same time that the dollar started strengthening.”
On the surface, funds-of-hedge funds have all adopted ‘a new song’ about the need for liquid portfolios. But the lead on changing the liquidity profile of hedge fund portfolios is coming, he claims, not from the funds-of-hedge funds but from the hedge funds strategies themselves.
Many hedge funds have changed from quarterly to monthly liquidity, while a significant number are cutting their notice periods from 60 or 45 days to 30 days.
