Hedge funds reshaped
A once high-flying industry, shaken by the financial crisis, is recovering with a new look
Wade Slome, MBA ’98, launched his hedge fund in January 2008,
just as financial storm clouds were gathering. A cascade of disasters
followed: Bear Stearns, Lehman Brothers, AIG, Bernie Madoff,
General Motors, and Chrysler. Slome’s fund absorbed big losses.
As the crisis continued, Slome, president of the investment firm Sidoxia Capital Management, decided to try to capitalize on it. With stocks at what appeared to be rock bottom, he began buying.
“The valuations that some stocks and securities were trading at was mind-boggling,” Slome recalls. “There were so many opportunities, it was like shooting fish in a barrel. Then prices dropped another 10 percent, so I bought more. You would put a toe or pinkie in the water, and it would get chopped off.”
Eventually, the strategy paid off. Markets finally rallied, helping to lift Slome’s fund, which he started with his own money and has not yet opened to outside investors. By fall 2009, its value was up approximately 70 percent from the start.
For hedge funds big and small, these have been turbulent times. The global financial crisis dealt a serious jolt to the high-flying industry, which serves wealthy individuals and institutions with nimble, lightly regulated investment vehicles. As the crisis unfolded, investors withdrew billions in assets, forcing scores of hedge funds to close. Total hedge fund assets plunged from over $2 trillion to approximately $1.3 trillion in early 2009.
“Assets under management crunched,” says Andrew Karolyi, professor of finance and global business at Cornell’s Johnson School. “The number of new fund launches basically dwindled to nothing. And many, many funds disappeared from the map.”
Associate professor of accounting Sanjeev Bhojraj says, “Hedge funds did not live up to the expectations that investors had built for them. The question is, ‘Is it the death knell of hedge funds?’ I would say, ‘Definitely not.’ “
A comeback but with a difference
Indeed, the industry has bounced back significantly in 2009. In
the same way that Slome’s small fund rebounded, hedge funds in
general have revived with the recovery in equity markets. In the
second quarter alone, total hedge fund assets were up 6 percent, and
assets under management began inching toward the benchmark $2
trillion figure again.
Investors also began a cautious return. Throughout the summer of 2009, inflows surpassed outflows. And according to HedgeFund. net, 75 percent of hedge funds reported positive performance for the first eight months of the year, and 25 percent of funds reported gains of more than 20 percent.
But even if hedge fund indices do return to pre-crisis levels, the industry has been permanently altered. Collectively, hedge funds are very different from what they were before the Wall Street meltdown, according to those who follow them.
Big hedge funds have gotten bigger, while smaller ones have fallen by the wayside. Investors have become more demanding, seeking more transparency, as well as changes to the generous compensation schemes hedge fund managers have enjoyed. And waiting in the shadows is government, both in the United States and elsewhere, eyeing curbs on what has been a largely unregulated industry. Senior Lecturer Richard Marin ’75, MBA ’76, teaches the popular course “The Search for Alpha,” which explores how hedge funds operate. “I’ve had to redo my course every fall that I’ve been teaching it,” Marin says. “That’s how much change is coming.”
“The financial crisis has changed the hedge fund landscape significantly,” says Bhojraj. “It used to be that just about anybody who could find some money could start a hedge fund. Now it’s going to be a lot tougher to raise money, and you have to show that you’re good.”
The crisis has, in effect, thinned the herd, leaving only the strongest still standing. According to Morgan Stanley’s prime-brokerage unit, the 100 largest hedge funds now control about 70 percent of hedge fund money, up from slightly less than 50 percent at the end of 2003. The approximately 300 hedge funds that are worth $1 billion or more now control about 85 percent of the business.
The surviving hedge funds are, for the most part, sophisticated operations with top-notch managers, independent administrators, and high quality auditors, according to Marin. “Three guys and a dog won’t cut it anymore,” he says.