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Foreign Exchange

Hedge fund victims of their own success

Does present poor hedge fund performance cast doubt on the broad validity of the sector or have new investors that flooded into hedge funds recently fallen for myths about their success and failed to see performance in a historical context? What is clear is that attempts to match capacity to demand have at least temporarily undermined some hedge fund strategies.

Investment style profiles

THE HONEYMOON FOR hedge funds is over. Having wowed investors with returns of 11.2% in 2003, 4.14% in 2002, 9.36% in 2001, 13.48% in 2000 and 15.35% in 1999, according to the S&P Hedge Fund Index, the sector will struggle to post double-digit annual returns for 2004 after experiencing its most challenging quarter since 1998.

The S&P index, which represents a broad range of hedge fund strategies, was down 1.59% for the second quarter this year compared with a positive 1.92% in the first quarter. In the third quarter of 1998 the index fell by 2.63%.

In the past six years, hedge funds assets have ballooned. Estimates from Chicago-based research and data firm Hedge Fund Research (HFR) suggest that in 1998 total assets under management at hedge funds were $375 billion. By 2004 that had risen to about $865 billion.

Leverage gives hedge funds crucial extra fire power. So although assets under management are relatively modest compared with mutual funds' $7 trillion, their impact on financial markets is similar.

In the accompanying articles Euromoney examines how hedge funds have moved from being peripheral players to the key drivers of many financial markets and vital to capital raising in the primary equity and emerging debt markets.

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