Hedge funds: global trends

After an unprecedented six months of losses, hedge fund performance to the end of November this year was -18.5%, according to Hedge Fund Research, which was the sour cherry on top of a torrid 2008.

So what, you might ask, considering that last year was grim for just about every area of financial services, what makes hedge funds so special? Well, their whole raison d'être is to provide high returns in any market.

They did, however, fare better than stocks. The Standard & Poor's 500-stock index lost 38% to November.

Poor performance is a big issue for hedge funds, which generally promise customers that they will recoup losses before taking their fee - this normally amounts to 20% of gains. This chart illustrates the drop off in performance recently.

And with performance taking a nose-dive, investors are withdrawing their money at a record rate. Data provider EurekaHedge estimates that the global hedge fund industry lost $100bn of assets in October alone.

Some of the bigger players have taken a hammering. Man Group, for instance, had assets under management of $70.3bn at the end of September, which had shrunk to $61bn at the beginning of November.

Other firms have taken the step of locking investors in to stop a mass exodus.

For an industry that notoriously keeps its cards close to its chest, it was a surprise that GLG Partners - which has seen its assets shrink by a third this year - announced plans for redundancies.

Citigroup estimates that hedge fund assets will fall 31% year-on-year to $1.3trillion by the end of 2008. Surprisingly, the bank says that 26% of this will be from reduced performance, with only a 6% decline resulting from fund outflows.

The most high-profile example of a bet that back-fired was hedge funds shorting Volkswagen stocks, which resulted a collective 24bn loss for a small band of firms.

Many expect to see ongoing consolidation of the hedge fund industry, or firms shutting up shop all together. One reason is the ongoing market turbulence and another is that a number of funds, who used Lehman Brothers as their prime broker, are no longer able to get access to their collateral held in the ex-investment bank.

Regulatory intervention has added to the woes of hedge funds to prevent them from shorting financial stocks. Touted as the scapegoats of the financial crisis, hedge funds have been banned by the Financial Services Authority in the UK from taking short-term bets on the stocks of a number of financial institutions until the end of January. The SEC in the US followed suit with a more short-term veto, which ended in mid-October, and other countries are looking to do the same.

Still, some hedge funds have done incredibly well out of the credit crunch. The best known is Paulson Partners, a US based fund which bet against sub-prime mortgages and managed to make a profit of $10bn across its funds. This was the most profitable trade in history.

This article was last updated on 5 January 2009

Click here for an explanation of the hedge funds sector.