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— Analysis —
A thinning of hedge fund ranks has already begun. In the past few weeks several funds have closed up shop, including the leading funds of MKM Longboat Capital Advisors LLP and Powe Capital Management LLP. Says Gurjit Kambo, an analyst at Numis Securities Ltd. in London, "Hedge funds were originally set up to protect investors against down-market conditions, but the performance figures for many have not been good. This will lead to redemptions by investors whose confidence has been dented."
-- Browse other stories in this Special Report -- Enter the giants Big, big and beyond Chain of fools Brrrrrrrr Neither short nor sweet Doffing the cap A well-known listed hedge fund, RAB Capital plc, is a case in point. In September it warned investors in its flagship Special Situations fund, which had lost nearly half its value since the beginning of the year, that the fund would have to close unless they committed their money to it for three more years in return for a cut in fees. The $923 million fund's biggest investor is the family of steel magnate Lakshmi Mittal. Separately, RAB is embroiled in a legal dispute following the bankruptcy of Lehman Brothers Holdings Inc. and has sued administrators PricewaterhouseCoopers LLP, demanding the return of some $50 million held by Lehman on behalf of one of the group's smaller funds. Investors are abandoning even well-performing funds. Says a senior hedge fund executive, "Redemptions are a problem for everyone. A big source of the problem is funds-of-funds, which are themselves suffering from redemptions." London-based Man Group plc, which analysts believe is the strongest U.K. hedge fund, with $1.5 billion of surplus regulatory capital on its balance sheet, has also felt the downdraft of investor flight. Redemptions in the first quarter of the year totaled $2.5 billion and rose to $3.4 billion in the second quarter, although the group still reported net new funds of $4.1 billion in the first half. Man's position in the market could be strengthened by consolidation, as it is in a comparatively good position to make acquisitions. "Consolidation is highly likely," says one fund manager. Kambo agrees: "In a fragmented industry, a rising regulatory burden means that small players will need to consolidate." The London market looked overcrowded even before the credit crunch began to bite. According to International Financial Services London, a trade association, there were about 1,000 hedge funds based in London by 2007, with total assets of $400 billion, amounting to some 90% of the European market and 20% of the global market. Many are struggling. A recent KPMG LLP survey of 20 small and medium-sized hedge funds found that some 20% of managers did not generate performance fees in 2007. Of course all portfolio managers must cope with the Financial Services Authority's growing list of financial stocks protected from short selling. This directly affects long-short equity funds, a substantial minority of the industry, and there are rumors that some of them plan to sue the FSA. For the moment, however, industry trade group Alternative Investment Management Association, or Aima, and leading fund managers have restricted themselves to verbal sallies. "Aima is actively consulting with its members worldwide as a result of the short selling bans on financial stocks that have been introduced. It is obviously an adverse development," says Andrew Baker, deputy chief executive of Aima, in a statement, adding that only a "small number" of funds shorted financial stocks. Ironically, Man Group, which acknowledged it had been marginally affected by the ban, itself asked to join the list of companies protected from short sellers. More than a few hedge funds will likely engage in more abject acts of humility in the months ahead. |
Church of England clerics have been railing against them, but that is the least of the worries plaguing U.K. hedge fund managers. Massive investor redemptions, scarce to nonexistent financing and, the latest insult, a regulatory ban on short selling will likely spark a major industry shakeout. In a still-overcrowded market (who wouldn't be tempted by a 2-and-20 fee structure?), strong players could pick up smaller rivals, and weak managers may simply disappear. 
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