1/05/09 - hedge funds

In today's excerpt - the popularity of hedge funds. The following excerpt was written just before the failure of Lehman brothers and the post-Lehman collapse of hedge fund performance. Prior to that time hedge funds had for some years enjoyed an almost mystical reputation as a superior investment vehicle:

"Of 1,308 hedge funds that were formed between 1989 and 1996, more than a third (36.7 per cent) had ceased to exist by the end of the period. In that period, the average life span of a hedge fund was just forty months. Yet ... far from declining in the past ten years, hedge funds of every type have exploded in number and in the volume of assets they manage. In 1990 according to Hedge Fund Research there were just over 600 hedge funds managing some $39 billion in assets. By 2000 there were 3,873 funds with $490 billion in assets. The latest figures (for the first quarter of 2008) put the total at 7,601 funds with $1.9 trillion in assets. Since 1998 there has been a veritable stampede to invest in hedge funds (and in the 'funds of funds' that aggregate the performance of multiple firms). Where once they were the preserve of 'high net worth' individuals and investment banks hedge funds are now attracting growing numbers of pension funds and university endowments. This trend is all the more striking given that the attrition rate remains high; only a quarter of the 600 funds reporting in 1996 still existed at the end of 2004. In 2006 717 ceased to trade; in the first nine months of 2007, 409. It is not widely recognized that large numbers of hedge funds simply fizzle out having failed to meet investors' expectations.

"The obvious explanation for this hedge fund population explosion is that they perform relatively well as an asset class with relatively low volatility and low correlation to other investment vehicles. But the returns on hedge funds according to Hedge Fund Research have been falling from 18 per cent in the 1990s to just 7.5 per cent between 2000 and 2006. Moreover there is increasing skepticism that hedge fund returns truly reflect 'alpha' (skill of asset management) as opposed to 'beta' (general market movements that could be captured with an appropriate mix of indices). An alternative explanation is that while they exist hedge funds enrich their managers in a uniquely alluring way. In 2007, George Soros made $2.9 billion ahead of Ken Griffin of Citadel and James Simons of Renaissance but behind John Paulson who earned a staggering $3.7 billion from his bets against subprime mortgages. As John Kay has pointed out, if Warren Buffett had charged investors in Berkshire Hathaway '2 and 20' (the typical fee and gain participation of a hedge fund manager) he would have kept for himself $57 billion of the $62 billion his company has made for its shareholders over the past forty-two years. Soros, Griffin and Simons are clearly exceptional fund managers (though surely not more so than Buffett). This explains why their funds along with other superior performers have grown enormously over the past decade. Today around 390 funds have assets under management in excess of $1 billion. The top hundred now account for 75 per cent of all hedge fund assets; and the top ten alone manage $324 billion. But a quite mediocre conman could make a good deal of money by setting up a hedge fund taking $100 million off gullible investors and running the simplest possible strategy."


Niall Ferguson


The Ascent of Money: A Financial History of the World


Penguin Group


Copyright 2008 by Niall Ferguson


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