Hedge funds launch, close in record numbers
More than 2,000 new funds were created, while nearly 850 liquidated, in a difficult 2005.
By Amanda Cantrell, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) - Last year produced a record number of new hedge funds -- but a record number of hedge funds also shut down during the same period, a new survey found.

The number of new funds created in 2005 rose 44 percent, climbing to 2,073, versus the previous year's addition of 1,435, according to Chicago-based hedge fund tracker Hedge Fund Research. On the other hand, 848 hedge funds liquidated -- meaning they closed operations and returned investors' money -- versus 296 fund closures the year before.

That's the highest number of closures ever in a single year, representing 11 percent of the roughly 8,500 hedge funds in existence.

While the boom in new launches is a positive for the hedge fund industry, the high number of closures serves as a reminder of the difficulty of keeping a hedge fund going, particularly if the fund launches into poor market conditions. When a hedge fund's returns plummet, investors often retreat, if a fund's losses are egregious enough. A large number of redemptions forces a manager to shut a fund down.

Hedge funds are private investment partnerships for wealthy individuals and institutions and can employ a variety of strategies, including anything from plain-old stock-trading to more complicated tactics like investing in the debt of emerging markets or betting on the outcome of mergers.

The record number of closures last year underscores the difficulty many hedge-fund managers faced in a tough return environment, as a once-profitable and popular trading strategy, convertible arbitrage, suffered a meltdown and returns for most strategies failed to excite.

"The hedge fund 'bubble,' while not popping, is no longer inflating," said Whitney Tilson, managing partner of New York-based money management firm T2 Partners and co-founder of the Value Investing Congress.

Estimates for hedge-fund returns in 2005 range from 2.28 percent to 9.35 percent on average, according to various hedge fund indexes that track performance. Measuring hedge fund returns is notoriously difficult, because hedge funds are private and frequently do not share information about their performance with anyone but their investors.

Still, hedge funds managed to raise $47 billion from investors last year, although the growth of assets dropped sharply compared to previous years, according to HFR.

"The level of assets that came into the industry, while lower than the year before, spurred both growth and liquidation -- the flip side of growth," said Josh Rosenberg, president of HFR.

Asset gathering got increasingly difficult in the later half of the year, particularly after a brutal October caused many hedge funds to report their worst month ever in terms of performance.

"Seeing a mixed performance year come on the heels of another difficult year in 2004, a record number of funds felt the pressure or succumbed to the fate of poor performance," said Rosenberg.

Tough time for funds of funds

Funds of funds accounted for 498 of the total new fund launches in 2005, versus 465 new launches the previous year. But 165 such funds liquidated last year, also the highest number of closures on record, versus 43 a year earlier.

Funds of funds lost assets last year as investors grew frustrated with low returns and high fees. Funds of funds saw two consecutive quarters of asset losses and raised only $9.5 billion for the year, compared with $33 billion in 2004 and $59.4 billion in 2003, according to HFR.

While investing in a pre-packaged portfolio of hedge funds is less risky than investing in a single hedge fund, it's also more expensive.

A typical fund of funds charges investors a management fee of one percent and a performance fee of 10 percent, on top of the fees the underlying hedge funds charge typically a two percent management fee and 20 percent of the fund's profits.

As frustrated investors began pulling money out of funds of funds, those managers were forced to redeem some of their hedge fund investments, dealing another blow to managers.

Tilson said even talented managers had a tough time raising money last year.

"Capital raising stalled out in part because last year was sort of a blah year," he said. "For any one who didn't have 30 percent to 40 percent returns, which is just about everybody, it's turned into a tough time to raise money."

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