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.
“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.’”
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