Tonight:
4°c
A credit crunch is the worst possible news for a highly borrowed business, and when it burst on a largely unsuspecting world it was inevitable that the hedge fund industry would be in deep trouble. Optimists predicted half the funds would be forced to close their doors, the pessimists said it would be two thirds.
The optimists were not far off the mark — the number of funds has indeed shrunk drastically and the industry as a whole is a lot more chastened today than it was then. But that said, and considering what the financial world is going through, it is in remarkably good shape. Very few funds have gone spectacularly bust; those going out of business have mostly done so in an orderly way, high-profile derailments such as the Northern Rock-induced trauma at RAB Capital have been largely dealt with, and the industry as a whole has coped remarkably well with a combination of enforced
de-leverage and client outflows. Hedge fund managers lost a lot of money and clients as their performance suffered but most of them kept the fabric of their business intact.
The result is the industry seems to be coming back strongly, albeit it is even more two tier now than it was then. The London market has always been polarised between a few big fund groups and a host of tiddlers. Many of the smaller funds have been knocked out, and there is little appetite for new, stand-alone fund launches at the bottom end, no matter how talented the managers — as discovered the hard way by ex-GLG trader Greg Coffey and other stars who wanted to go solo.
But the good news is that pension funds — much more than private clients — are now moving money back into the sector as they seek to de-risk their funds by diversifying out of equities. Most of this is going to the big survivors and particularly those which seem back on the growth tack after the upheavals of last autumn, and according to data published yesterday by Prequin, a research boutique, the bigger institutional investors have been able to use their clout to get a reduction in fees with the means for the industry shading from a management fee of 2% and performance fee of 20% to 1.6% and 17.2% — a trend which seems likely to continue. It's important not to over-egg this, however, as seven out of 10 funds are still holding to their 20% performance fee, and those with the best records — or the most relevant current strategies like for example distressed debt — seem not to be budging at all.
Recruitment is a lot easier too. Last autumn the industry was shedding staff and cutting costs, but now it is recruiting selectively again and finding a lot more talent available given the lessening of competition from the investment banks for the kind of people it needs. Indeed, RAB Capital's chief executive Stephen Couttie said when announcing the group's figures this week that it had the opportunity, if it so chose, to get “significant new hires” as it moved to rebuild its business. It helps too that while bankers' pay has become highly politicised, no one pays much attention to what goes on in their still largely private world.
Hedge funds have always deployed more brain power per million pounds under management than has the traditional fund management industry, and this if anything is likely to be enhanced. How traditionally long-only fund managers will respond is a moot point.
Another area of pain is among fund of hedge fund managers, but even here they are regrouping. Some were caught out by the crash and trapped when they wanted to exit. Some, especially those set up by banks for their clients, were under resourced, and others had their credibility destroyed by putting too many customers into Madoff. Those which focused on private clients continue to struggle, but those who specialise on advising institutions are sharing in the upturn.
There are other changes. Investors are demanding and getting more transparency and candour about investment strategy — and getting it — which is no more than you would expect in a post-Bernard Madoff world still bemused about how he could have got away with his fraud got so long. There is also much less leverage, though one wonders for how long, given the margins and spreads currently available for the brave trader and the determination of some investment banks to go back to business as usual.
Indeed, as the threat of extinction recedes, the industry's major problem comes from being lumped with private equity in the eyes of European lawmakers. Many of the leading mainland politicians are fundamentally opposed to the staple product of private equity — the leveraged buy-out — which they associate with asset stripping, job losses and all that is bad about financial engineering, as good businesses are turned into zombies by being smothered with debt. That is not what hedge funds do but they are having trouble getting that message across, and unless they do they may have to learn to live with a lot more intrusive regulation.
Interestingly though, that is the only real cloud on their horizon.
Everything else, from good trading markets to renewed inflows of cash, is going their way.
That really is not something one would have forecast six months ago.
