Investors still have some faith in hedge funds

Date: Wednesday, March 25, 2009
Author: Zachery Kouwe, International Herald Tribune

That, anyway, is the conclusion of a closely watched industry survey, that was to be published Tuesday, that paints a sobering portrait of what was once one of the highest-flying businesses on Wall Street.

After years of explosive growth, hedge funds, those sometimes volatile pools of private capital, are undergoing a shakeout. But according to an annual survey of hedge fund investors conducted by Deutsche Bank, things may not be as bleak as many hedge fund managers fear.

Despite gaping losses at many funds, most of the investors polled by the German bank said they believed that hedge funds would post returns of 5 percent to 10 percent for 2009, besting the broader financial markets.

That vote of confidence comes at a pivotal time for hedge funds, which could play a role in the bank rescue plan announced by the Treasury Department on Monday.

The government hopes some of the funds will buy troubled assets from the nation's banks, helping stabilize the financial system and the economy.

Even so, hedge funds — whose outsize rewards helped define the era of mega-paydays on Wall Street — are undoubtedly going through a rough period, and the pressure is unlikely to let up soon. According to the Deutsche Bank survey, the industry's assets under management are expected to decline by $200 billion over the next year, to $1.33 trillion. In 2007, near its peak, the industry oversaw more than $2 trillion.

Many investors have withdrawn money from the funds recently, and 82 percent of the respondents said such redemptions would be the most challenging issue the industry faced in the next 12 months, according to the Deutsche study. Along with increased regulation and calls for more transparency, the withdrawals are expected to force many smaller funds to shut down or consolidate.

"There is a Darwinian process that has been going on and will continue into this year," said Jonathan Hitchon, co-head of global prime finance for Deutsche Bank. "There are a lot of hedge fund managers that will be left out in the cold."

The report surveyed various types of hedge fund investors, including funds of hedge funds, family offices, pension funds, endowments and wealthy individuals. The bank polled about 1,000 investors worldwide.

Most of the investors are planning to reduce investments in emerging markets in Asia, excluding China, as well as in Russia and Eastern Europe. Sixty-three percent said they planned to add to or maintain their investments in the United States and Canada. More plan to reduce their allocations to Western Europe than plan to add to them.

In a big shift from recent years, most hedge fund investors have cut back on the amount of borrowed money used to leverage their bets on particular funds. According to the survey, nearly three-quarters of investors have reduced their exposure to leverage in the past 12 months, and most said they did not plan to increase it this year.

Transparency and risk management have become major issues for investors after many got burned in hedge funds that had invested with Bernard L. Madoff. Investors are demanding that hedge funds, rather than pooling all investors' money, place their investments in separately managed accounts that provide daily information on positions and profits.