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In association with Hedge Fund Intelligence |
A full-blown restructuring is under way in the hedge fund world – in what is still a young industry subject to intense Darwinian forces. The shake-out will be severe and the casualty list has been lengthening by the day.
On the positive side of the ledger, it seems highly likely that huge opportunities will exist in a much less crowded, smaller and nimbler industry. But they will only be available to those that can survive through this period of pain.
The whole landscape is changing. There will be profound transformation in fund structures, fee levels and through the creation of different types of vehicles to cater for the different requirements of different types of investors – and for different types of investment opportunities in different asset classes and strategies with different degrees of liquidity.
The withdrawal of investor capital – and of investment bank leverage – from an industry that had enjoyed many years of headlong expansion is proving to be a widespread, painful and complex process.
The destruction of wealth that has been seen in so many areas is dispiriting to all who believe that hedge funds should offer investors a defence against difficult markets as well as decent returns in more benign periods.
And to see many funds in a state of virtual conflict with their investors and prime brokers – resorting to expensive lawyers to handle the ensuing chaos – is a deeply unedifying spectacle that plays straight into the hands of the industry’s detractors.
Many hedge funds have managed to perform far better than equity markets – which were down by 40% or more in 2008 – and many funds in many strategy areas have performed very well indeed, as we will be highlighting at our annual EuroHedge Awards in late January.
However, across the industry at large the preservation of capital has been poor and it is hard to escape the conclusion that, collectively, hedge funds have failed to do what they are supposed to do – even in such extreme conditions as those of the past few months.
As with any restructuring, however, it is essential to ensure that the baby is not thrown out with the bathwater. Many funds – and strategies – have failed. And they plainly do not deserve to survive. But that is not the case for the entire industry.
Anyone investing in hedge funds should be doing so in the expectation of solid and consistent risk-adjusted returns through the market cycle. Funds should not be judged solely on a single year’s performance – or even, arguably, on the basis of their performance in just one type of market environment.
On the other hand, managers that offer liquidity to investors must be aware that those investors are likely to pull back in times of stress – irrespective of performance. Surprising as it appears to be to many managers, it is just as logical and obvious that investors should seek to redeem from funds where they can take profits (just as anyone would do with a portfolio of stocks, for instance) as from those where they are losing money and simply want to get out.
And it is naive not to assume that bank counterparties will also lose their appetite for risk in times of stress – or to be unable to cope when they inevitably start to tighten their terms. That is how banks operate.
Mark Twain’s description of a banker as someone who lends you an umbrella when the sun is shining and asks for it back when it begins to rain is well known and oft-quoted. But it is surprising how often it is forgotten – or ignored.
It is quite clear that any number of funds and firms have failed to prepare themselves for a rainy day. They did not stress-test their strategies. They did not think how their investors might react. They did not consider how market dynamics might change. And they did not ask what steps their counterparties might take.
Of course, recent events have been extreme. But to leave one’s business so exposed to a downturn is rank bad management – and it shows that the industry still has a lot of growing up to do in blending skilled investing with business savvy.
It is that combination that marks out the true survivors and winners in this industry. Running a sustainable independent investment business is no easy matter – not any easier, for instance, than managing a strategy that is supposed to perform in all market conditions.
It requires proper business management. It requires true alignment of interests between managers, investors and counterparties. And it requires a strong instinct for self-preservation.
The one-size-fits-all model is bust. Structural change is coming to every aspect of the hedge fund industry – and it is to be welcomed. Better governance at every level is its best hope of long-term prosperity, sustainability and respectability. And all those who survive this battle will be immeasurably stronger and wiser for the experience.
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In association with Hedge Fund Intelligence |
