Hedge Funds Get Marginally Less Awesome For Managers

Fees fell slightly and liquidations increased, but the industry has record capital
Photograph by Henrik Sorensen/The Image Bank via Getty Images

Ever so slightly, modest changes are starting to affect the $2.2 trillion hedge fund industry.

Make no mistake, the 2-and-20 business is rolling right along. Some $31 billion has flowed into hedge funds this year, according to a report published Dec. 11 by Hedge Fund Research, and the industry has more capital than ever. That’s despite the fact that 2012 has been yet another year in which hedge fund gains have trailed the S&P 500-stock index—1.5 percent versus 13.8 percent, according to Bloomberg’s aggregate measure.

There are signs, though, that underperformance and high fees are finally having an effect. If HFR’s numbers hold through December, fewer hedge funds will have launched and more hedge funds will have shut down in 2012 than in 2011. So far this year, 824 funds have launched and 635 have closed, a balance of 1.3 to 1. That ratio had been improving since hitting a low in 2008, during the financial crisis, but is now on the way down again.

Hedge funds’ notoriously high fees are also showing signs of weakening. Managers once typically charged a 2 percent fee on the assets they managed, plus a 20 percent cut of profits. HFR found that in the most recent quarter, management fees fell by the smallest of margins—1 basis point, to 1.56 percent—while incentive fees fell 14 basis points, to 18.62 percent. (One basis point is equal to 0.01 percent.) So fund managers who earn his investors a fraction of what they could get in the common stock market will now be compensated marginally less for their efforts.

This year has seen a steady beat of notable fund closures. Diamondback Capital Management said it was liquidating, Bloomberg News reported on Dec. 6, after investors asked to take back more than a quarter of the fund’s assets; the firm’s offices were raided by the Federal Bureau of Investigation in 2010. A Bloomberg News report on Nov. 30 carried news of two closures: Kleinheinz Capital Partners, whose founder told investors “I am not enjoying running the fund as much as I used to,” and Corriente Advisors, which cited years of “extremely poor and disappointing performance.”

Also shutting down: Ridley Park Capital, citing impatient investors; OMG Capital, confronting a “brave new world”; Libra Advisors, a $2 billion firm; John W. Henry & Co., owned by the Boston Red Sox patriarch; Edoma Partners, a Goldman Sachs-pedigreed fund; and dozens of others.

A number of funds throwing in the towel cited increased regulatory burdens, although one early study found their effect to be exaggerated.

Through the first half of 2012, according to HFR, the greatest number of liquidations have come among equity hedge funds, followed by “macro” funds, which make bets based on broad economic trends. In the first half of the year, 143 of the former and 64 of the latter closed, according to HFR. Also shutting down were 135 funds-of-funds.

More funds started than shut down. In the third quarter, 275 launched, bringing HFR’s total count of single-manager funds to 7,867, an all-time high. (The previous high, set in 2007, had been broken in the first quarter of 2012.) Funds-of-funds have not recovered in the same way. Their count has steadily fallen since the financial crisis, to 1,897.

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