Hedge funds have gone from ‘Brad Pitt’ to the pits

Hedge funds used to be the “Hollywood” end of the funds management business. But just like illegal downloading is slashing Brad Pitt’s salary, the hedgies are being trimmed by investor caution, aversion to high fees and the fact there’s too many still hanging on from the good old days.

The Brad Pitts of hedge funds are feeling it, too. Consider John Paulson (pictured), who went from hero, making $US10 billion in essentially one trade against sub-prime mortgage securities, to zero after being fooled by China’s Sino-Forest Corporation. Or Australia’s Greg Coffey. He was buying castles, now his boss at Moore Global Investors, Louis Bacon, is handing back billions to clients in the hope that his stable of hedge fund managers, including Coffey, can start outperforming term deposits.

A new report from HSBC sees two big problems for hedge funds. One is the trendless, risk-on risk-off type of market that has hurt hedge fund performance for two years. The average hedge fund (of the thousands monitored by EurekaHedge) was only up 2.5 per cent for the year to the end of July, well below the 7.5 per cent posted by global equities and on a par with bonds – a far cheaper asset class than hedge funds, where a 2 per cent annual management fee and 20 per cent “performance” fee used to be the norm. (Amazingly, many hedge funds would still get paid a performance fee on this year’s dismal numbers, given they typically kick in at the “risk-free” rate, which is close to zero in many parts of the world.)

Investors of course have revolted against 2-and-20, pulling money from hedge funds and putting it into “multi-asset” or long/short funds run by large institutions, which have the scale to afford much lower fees. This hopefully will cause many of the marginal hedge fund houses to shut because, as HSBC eloquently states, the past popularity of hedge funds has become their other big problem.

“When the universe of hedge funds was small enough, there was still alpha [above-market returns] for them to harvest. In essence, they were getting their alpha from traditional long-only fund managers. But, once hedge funds became a $US1trillion-plus community, they increasingly had to get their alpha from each other.”

Until there’s fewer of them, the hedge fund industry will remain akin to a B-grade cannibal movie.

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