Hedge Fund Closures

Hedge funds are closing down at a record rate not seen since the financial crisis. In the first half of the year, 461 funds closed, Chicago-based Hedge Fund Research Inc said. If that pace continues, it will be the worst year for closures since 2009, when there were 1,023 liquidations. Probably no one is shedding tears for these money managers, with the exception of investors who backed them. But who knows, their misfortune may be their fortune. The guys booted from the casino empty handed might end up doing something useful with their lives, after all, as one legend trader said, there has got to be more to life than making rich people even richer. 

So what’s the reason behind this high closure rate? 

In a word, returns, specifically dismal returns from a large number of the hedge fund managers, which have underperformed the wider index. “Most hedge funds have not performed extraordinarily well,” said Stewart Massey, chief investment officer at Massey Quick & Co. in Morristown, New Jersey, which invests in the private partnerships. He expects that redemptions will hit small-and medium-sized firms this year, reducing assets to a level where “they will have to make a decision whether to carry on or not.” 

Brevan Howard Asset Management LLP, a $37 billion asset, is now the latest firm to throw the towel in and close a fund. Last week it pulled the plug on its $630 million commodity fund managed by Stephane Nicolas after it tumbled 4.3 percent this year through the end of October, according to a person working for the firm.

There is a debate ongoing whether hedge funds should exist. One school of thought argues that hedge-funds add to financial instability in the markets. But another view argues the contrary, that hedge-funds help bring about efficient pricing in the market. However, one thing undisputed is that those at the top of the game are money making machines. It is a high risk, high reward activity where a few big players tend to be consistantly getting it right and winning big. For that very reason, the hedge fund industry will have the financial muscle to lobby policy-makers, grease their palms and hire top professionals to fight their corner. Big money always gets its way in the end, so hedge funds will very likely continue to be part of the ecosystem. 

Hedge funds trade derivative products so they profit irrespective of whether the market trades up or down. The name of their game, as is with all investors/traders, is to profit from market volatility. However, they’re enormous in size compared to the average investor, since they are able to borrow huge amounts of money and leverage to generate spectacular profits, or loses. 

The market in which hedge funds operate is massive in size and many times bigger than the primary market. These companies are not regulated and are all in off shore jurisdictions. The mortality rate is relatively high in the industry.

Philippe Jabre, Manages Jabre Hedge Funds, personal wealth 200 million pounds sterling. “You are allowed to make a mistake once, but if it is a bad one you are out. You are the ultimate risk taker,” he added. Using funds from a few wealthy clients and also borrowing massive amounts of money, colossal fortunes in profits have been made by some hedge funds. In 2006 approximately 10 of them made more than 500 million dollars each. 

So with the recent collapse in the oil price, the commodity sell-off and the sharp decline in the Russian economy, those hedge fund managers who did not see it coming have been wiped out. Hall Commodities LLP, a London-based $100 million hedge-fund firm run by Tony Hall and Arno Pilz, told clients in October that it’s shutting down after less than two years, citing poor performance. The industry operates in an opaque environment, but with the same cut-throat law of survival of the fittest. This probably explains the reason why the industry is experiencing a shake-out now.

A number of hedge fund managers are struggling to regain after years of losses. Dan Arbess said last month that he’s closing his Perella Weinberg Xerion Fund after failing to recoup a 21 percent loss dating from 2011. The fund, which focused on distressed credit and special situations, hadn’t been able to charge any performance fees since then. 

Hedge funds, on average, have returned just 2 percent in 2014, their worst performance since 2011, according to data compiled by Bloomberg. Smaller funds have struggled to grow as institutional investors flocked to the biggest players. In the first half of 2014, 10 firms including Citadel LLC and Millennium Management LLC accounted for about a third of the $57 billion that came into the industry.

Many of the closures have been among macro funds, which have returned less than one percent this year, on average, according to Bloomberg data. Macro managers have complained that in an environment of low interest rates and muted swings in prices, it’s difficult to make money.

Josh Berkowitz’s Woodbine Capital Advisors LP said earlier this year that it was closing down after assets dwindled to $400 million from a peak of $3 billion four years ago. Keith Anderson's Anderson Global Macro LLC and Kingsguard Advisors LP, started by two former Goldman Sachs Group Inc. traders, both shut after less than three years in business.

So it looks like we are seeing a consolidation in the industry with just a few big players left and receiving all the finance.