As hard times hit hedge funds, in­vestors take $16 bil­lion off the ta­ble

In six months, in­vestors have with­drawn $16 bil­lion “Peo­ple are wor­ried about their jobs”

Bloomberg Businessweek (Asia) - - CONTENTS - Kather­ine Bur­ton The bot­tom line Money is mov­ing out of hedge funds in re­cent months, and the in­dus­try is started to look crowded.

Doug Dil­lard fol­lowed the path that once al­most guar­an­teed en­trance into the 1 Per­cent: Good col­lege (Georgetown), in­vest­ment bank (Mor­gan Stan­ley), MBA (Har­vard). Then a hedge fund. A decade out of business school, he was head­ing Stan­dard Pa­cific Cap­i­tal, a multi­bil­lion-dol­lar San Francisco firm that traded global stocks. It did well by its clients, mak­ing money in 2008 as mar­kets plum­meted.

But Dil­lard’s re­turns—like most other hedge fund man­agers’—failed to keep pace in the post-Great Re­ces­sion bull mar­ket. In­vestors ex­ited. In Fe­bru­ary, when as­sets slid be­low $500 mil­lion, Dil­lard pulled the plug. “It has re­cently be­come clear to both of us that some­times there is a log­i­cal con­clu­sion to even a good thing,” he and his part­ner, Raj Venkatesan, wrote to clients.

They aren’t the only ones think­ing their good thing might be gone. On April 26, Third Point man­ager Dan Loeb, one of the hedge fund elite, wrote to in­vestors that the in­dus­try is “in the first in­nings of a washout.” At

“It has re­cently be­come clear to both of us that some­times there is a log­i­cal con­clu­sion to even a good thing.” ——Doug Dil­lard and Raj Venkatesan, on clos­ing their hedge fund

the an­nual Berk­shire Hath­away share­holder meet­ing at the end of April, War­ren Buf­fett told in­vestors to keep money away from hedge funds be­cause of their high fees and lousy re­turns.

“Peo­ple are wor­ried about their jobs,” says Ed­ward Magi, who sells real es­tate for Wil­liam Pitt Sotheby’s in South­port, Conn., an area pop­u­lar with hedge fun­ders. He’s seen two mul­ti­mil­lion­dol­lar deals fall apart this year be­cause the buy­ers lost work. Hedge funds have gone through tough patches be­fore, but this one is dis­qui­et­ing, as the broader in­vest­ing world isn’t in cri­sis mode. The S&P 500-stock in­dex, af­ter a rocky start to 2016, ad­vanced about 1.3 per­cent in the first quar­ter. Hedge funds lost an av­er­age of 0.6 per­cent.

The worry for the hedge fund crowd is that their business model is bro­ken. The funds, gen­er­ally avail­able only to wealthy in­vestors, may choose to make big bets on just a few ideas, or that se­cu­ri­ties will fall in value as well as rise. Be­cause their port­fo­lios can dif­fer so much from mar­ket in­dexes, the best can make money even as mar­kets fall. The seeds of trou­ble were planted af­ter 2008, when the mar­ket melt­down con­vinced many to re­treat from junk-grade bonds and other less-liq­uid se­cu­ri­ties. Now, roughly half of all hedge fund as­sets are fo­cused on equities, ac­cord­ing to Hedge Fund Re­search. More man­agers may be go­ing af­ter a fi­nite set of promis­ing trad­ing ideas, di­min­ish­ing re­turns as they crowd in.

What’s more, 312 firms have at least $1 bil­lion in as­sets, ac­cord­ing to a sur­vey pub­lished by Ab­so­lute Re­turn. Some po­ten­tially prof­itable mar­ket niches are too small for these funds to in­vest in.

Even some high-pro­file man­agers are strug­gling. The funds of Alan Howard and Richard Perry—once con­sis­tent win­ners—were down in the first quar­ter, af­ter two years of losses. The S&P 500 re­turned a cu­mu­la­tive 16.7 per­cent in that pe­riod. Bill Ack­man of Per­sh­ing Square, a man­ager peo­ple fol­lowed into what­ever stock he bought, has lost $5.5 bil­lion on his core strat­egy in just 15 months, pri­mar­ily be­cause of one bet on Valeant Phar­ma­ceu­ti­cals.

In the past two quar­ters, in­vestors have pulled more money from hedge funds than they put in—al­most

$17 bil­lion—the worst out­flow since 2009. More are de­mand­ing that strug­gling funds lower the fees of 2 per­cent of as­sets and 20 per­cent of prof­its they’ve typ­i­cally charged.

Port­fo­lio man­agers can still do very well: Head­hunters say last year even a los­ing firm may have paid man­agers bonuses of $1 mil­lion or more. But for those who are cut loose or leave a job, it’s not un­usual to be out of work for a year. Over a burger at P.J. Clarke’s in Mid­town Man­hat­tan, one man­ager who asked not to be named says he was con­fi­dent when he left his job in 2014 that he’d have lit­tle trou­ble start­ing his own firm. He’s still try­ing to raise the money. Mean­while, the rent on his of­fice is eat­ing into his sav­ings.

Hedge funds still com­mand $2.86 tril­lion in as­sets, about $1 tril­lion more than in 2007. And many in­vestors still can’t re­sist the prom­ise of a man­ager who’ll outdo a plain-vanilla port­fo­lio. A $100,000 in­vest­ment in the S&P 500 in Fe­bru­ary 1997 would be worth $6 mil­lion to­day; the same amount in­vested with Paul Singer’s

El­liott Man­age­ment would have grown to more than $14 mil­lion, af­ter fees. Both Cal­i­for­nia’s and New York City’s pub­lic-em­ployee pen­sion funds re­cently swore off hedge funds, but the Cal­i­for­nia teach­ers’ fund is adding to its al­lo­ca­tion.

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