Hedge Fund Industry Sees Downturn | Discussion Notes

Industry Sees Downturn

Hedge Fund Industry Sees Downturn

Here is a short guest post from a fellow investment blogger:

I am reading an avalanche of stories about shakeouts happening in the hedge fund industry. As we mentioned earlier in the fall, we expected many to close their doors because they cannot earn performance fees (generally 20% of all profits) unless they hit a high water mark (i.e. until their investors are made whole they generate none of those fees) so we expected many to just close up shop at the end of the year. [Sep 23: Fee Slump Hits Hedge Funds] But this market has gotten so much worse since we first advanced that idea [Oct 3: Hedge Funds Have Worst Month on Record], and the forced selling from going off of leverage is ruining performance for many others - that their investors will in fact (by walking) force a lot of closures. [Sep 3: Hedge Funds Get Rattled as Investors Seek Exits]

Here is one story out there but I am sure many walk in his shoes

* Only 10 months ago, Remy Trafelet was so flush that he treated about 100 employees at his hedge fund to a getaway in Venice. He and his crew spent a long, luxurious weekend at the five-star Hotel Bauer, which has Murano glass chandeliers, private gondoliers and a splendid view of a 17th-century basilica.

* But now, a bit like Venice, Mr. Trafelet’s hedge fund seems to be sinking. His flagship fund has fallen about 26 percent this year, and Mr. Trafelet is struggling to hold on to anxious employees, as well as some investors.

* Perhaps the most remarkable thing about Mr. Trafelet is that he is not so remarkable at all. Thousands of hedge fund managers like him — mostly young, mostly male and virtually all unknown outside financial circles — confront a sober reality: for now, the days of easy money are over.

* The economics of the hedge fund industry, so lucrative on the way up, are trying even the most seasoned managers on the way down. Hotshots who amassed millions or even billions of dollars from deep-pocketed investors are struggling to persuade those backers to stick with them. For the $2 trillion hedge fund industry, a long-feared shakeout is at hand. Some analysts say one out of every 10 funds could fold. (I think it will be much higher)
* Mr. Trafelet, who is 38 and first made his name managing money at the mutual fund giant Fidelity, insists his Trafelet & Company will be one of the survivors. He has been through rough patches before and says he is not about to give up now. “There is an easy way out, but I’m not the one who is going to take it,” Mr. Trafelet said in an investor call on Thursday. “I feel an absolute personal and moral obligation to work as hard as possible especially through a difficult period.”

* His fund has dwindled to about $3 billion, from $6 billion at its peak in 2006. It has been three years since he produced the kind of double-digit returns that many funds generated in the industry’s heyday, before thousands of new managers crowded in and made spotting profitable trades far more difficult.

* But Trafelet, founded in New York in 2000, is in a weaker position than other hedge funds because the fund returned only 6 percent last year and 2 percent in 2006, according to an investor. Investors who are evaluating whether to leave Mr. Trafelet’s fund versus other funds may choose to remain with funds that made them more money recently.
* In recent years, public and corporate pension funds, endowments and foundations poured money into these private investment vehicles in the hope of reaping market-beating returns.
* So far this year, the average hedge fund is down 17 percent, about half as much as the Standard & Poor’s 500-stock index.

* As losses mount, hedge fund managers are consulting lawyers to determine whether their fiduciary duty dictates that they should shut their doors, liquidate their holdings and use the proceeds to pay back investors — before the losses get worse — or stay in business and try to trade their way out of the hole.

* In the hedge fund world, traders have remade their fortunes dozens of times over, and Mr. Trafelet may impress again in the coming years. [Mar 28: Founder of Long Term Capital Failing Again]

* It has been quite a ride for Mr. Trafelet, who developed his taste for stock-picking while attending the elite boarding school Phillips Exeter Academy. After graduating from Dartmouth College, he took a job at Fidelity. By age 25, he was managing a $500 million mutual fund. (sure, make me feel even worse)

* Today, Mr. Trafelet enjoys the trappings of success and is still rich by most standards. He has a home on Park Avenue and takes vacations in places like Fishers Island, the private island in Long Island Sound whose beaches have long attracted old money. In a single good year like 2005, his fund generated hundreds of millions of dollars, which would have been divided between Mr. Trafelet and a few partners after paying expenses.

* Unlike some hedge fund traders who use complicated computer models and formulas to spot investments, Mr. Trafelet picks stocks the old-fashioned way: by combing through corporate fundamentals like profits and sales. (aha, we found where he went wrong - HAL9000 has another victim - old fashioned stock picking? That is so 1990s - hello in this age you need to send your 480 super computers to fight hedge fund B's 560 super computers! may the best algorithm win! Or you are completely in and out of all your trades - made by those slinkly humans - by 4 PM each day - that's "investing" now) He lost big on his largest position, the Ultra Petroleum Corporation of Houston, which plunged from $84 three months ago to $40 on Monday, before the broad market rally lifted the stock.
* In the middle of September, when regulators temporarily banned short-selling, Mr. Trafelet, like many hedge fund traders, was squeezed. He had to exit some short positions. By the time the month was over, he had lost a stomach-churning 18.5 percent, according to an investor.

* Others in the industry started asking questions when Mr. Trafelet laid off a sizable portion of his back-office staff in the middle of the month. He says those cuts were because of a technology upgrade. Last week two more senior employees left. Mr. Trafelet said the departures were not because of the fund’s performance.

* He has to retain his staff to have any hope of pulling back into the black. At the end of August, he personally guaranteed bonuses for his top traders for this year and told them that, if needed, he would pump more of his own money into his fund in 2009 to safeguard their pay.

The stress levels in London and New York City nowadays must be off the charts.

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Tags: hedge fund industry down for the year, how much money have hedge funds lost this year, hedge fund performance losses example, story of hedge funds losing money

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