Hedge Fund Turmoil Continued During 1Q; Nearly 400 Liquidations

Hedge-fund liquidations continued at a breakneck pace during the first three months of 2009, but cooled off from the record number of collapses seen during the market meltdown at the end of last year.

According to new data released Tuesday by Hedge Fund Research, 376 hedge funds closed during the first quarter, bringing the total number of funds that have disappeared since mid-2008 to nearly 1,200.

However, the 376 funds closed last quarter is down 50% from the record level set during the previous quarter amid the height of the credit crisis. Still, the first quarter’s attrition rate of 4.05% is the second-highest rate ever, exceeded only by the previous quarter’s 7.77% rate.

“Although risk aversion began to recede from historical levels in Q1 2009, the structural consolidation which has been ongoing for several quarters, continued to transform the landscape of the industry,” Kenneth Heinz, president of HFR, said in a statement. “We expect that the combination of the structural evolution and recent performance will continue to drive industry growth and change in 2009.”

Many funds were forced to close over the past several quarters as the three major indexes lost as much as 40% of their value as Wall Street feared the worst for the economy. The selling continued during the first quarter as the Dow Jones Industrial Average hit a 12-year low in early March.

“It looks like they’ve adjusted their strategists to the current environment to at least minimize losses, if not actually see performance gains,” said Adam Sussman, director of research at Tabb Research. “A lot of the issues that caused funds to close had to do with demand for liquidity from the end investor. As that has abated, so to have the number of closures.”

Hedge funds can expect to have a much stronger performance this quarter as stocks have surged off their worst levels amid evidence the recession stopped getting worse and growth could be possible later this year. The Dow has climbed as much as 35% above its March low and the S&P 500 and Nasdaq Composite have turned positive year-to-date.

While overall liquidations slowed during the first quarter, closures of fund-of-funds picked up steam as a record 200 were liquidated, accounting for nearly half of all hedge fund closings, the data showed. Less than 100 fund-of-funds closed in the previous quarter. Funds-of-funds are mutual funds that own shares of other mutual funds.

Despite the industry turmoil, HFR said 150 new funds launched during the first quarter -- the highest rate since the second quarter of 2008.

Amid continued market volatility, diversity of performance continued in the hedge fund industry last quarter. HFR said a spread of nearly 93% separated the best and worst performances over the trailing 12-month period, down from 103% for all of 2008.

Thanks to their spotty performances, management fees at funds of funds fell by three percentage points from a year ago. Ironically, funds with lower management fees have outperformed those with higher fees over the last year, the report said.

Sussman said many hedge funds are optimistic cash will return to the industry but with the investor gaining the upper hand. 

“I think those fund flows are going to [return] with a cost of more controls over how the assets are handled and the ability to call on those assets when needed,” said Sussman, who said a number of funds now allow monthly redemptions instead of quarterly. “I think the balance of power is shifting more toward the end investors than the hedge funds.”