Number of hedge funds may be headed down
Analyst says funds that have just one strategy may find it difficult to stay ahead.
NEW YORK (CNNMoney.com) - The number of hedge funds could fall sharply in the next few years as funds that follow just one investment strategy will find it hard to make returns, an industry veteran said Tuesday.
"It's so hard to be a single-manager, single strategy fund now," said Tanya Styblo Beder, chief executive of Tribeca Global Management LLC, the multi-strategy, proprietary hedge fund unit of Citigroup. "There is a lot of uncertainty in that space because it is hard to know how to put up returns (consistently enough) to maintain investors."
Hedge funds are private, lightly regulated investment pools for wealthy individuals or institutional investors. The funds use a wide variety of strategies, from betting on or against stocks, currencies or commodities to more esoteric strategies involving "derivative" investments or turning around distressed companies. But they generally won't welcome individuals as investors unless they have a net worth of at least $1 million.
Beder, speaking at an event hosted by Citigroup's alternative investments division, said she expects the number of hedge funds operating today to drop by "several thousand" over the next few years. That's because trends in the markets are happening faster, meaning strategies go in and out of favor more rapidly, she said.
So what will happen to all that money and trading talent? Beder, who headed the strategic quantitative investment division of well-known hedge fund Caxton Associates before joining Tribeca, said she thinks multi-strategy hedge funds, which employ a variety of different investing styles, will absorb many of the assets that once would have gone to single-strategy shops.
Many hedge fund strategies go through cycles, and as specific strategies go out of favor, investors run for the exits, she said. But when they go back into favor, investors clamor to get back into those same strategies.
Beder said the consolidation will also extend across funds of funds, which are pools of capital that invest in hedge funds. Funds of funds charge clients an additional management and performance fee on top of the fees charged by the underlying hedge funds themselves.
As the manager of a multi-strategy shop, Beder has reason to proselytize on the benefits of investing in a multi-strategy hedge fund. But some fund-of-fund industry veterans have made the same prediction - that their industry will also see closures and consolidation, as smaller funds of funds close down and their assets flow into bigger funds of funds or multi-strategy funds.
These people say they think the very largest funds of funds, which run billions in assets, will survive the wave of consolidation.
Multi-strategy hedge funds differ from funds of funds in that rather than "outsourcing" their investments to individual hedge funds, they employ their own managers and traders, who execute a variety of different investment strategies.
Multi-strategy funds allow firms to quickly move money from one strategy to another, Beder said, noting that many single-strategy hedge funds lock up investors' money to prevent the types of stampedes that can cause funds to close.
She cited last year's meltdown in hedge funds running convertible arbitrage strategies, in which managers seek to profit from pricing differences in a convertible bond and the same company's common stock, as an example.
Many large convertible arbitrage hedge funds were forced to close last year as the strategy suffered losses and investors in these funds cashed in their chips. But the strategy has bounced back this year, with the Merrill Lynch convertible arbitrage index up nearly 5 percent through the first week of June.
Because hedge funds are private investment funds, it is impossible to know exactly how many hedge funds are in existence today, but estimates range from about 8,500 to 10,000.
Beder said the trend of consolidation in the hedge fund industry is already under way. But she expects that poor performance by many managers in May will accelerate it. Many hedge funds took it on the chin during the recent market correction at the end of May, owing to sharp declines in metal prices, declines in the broader stock markets and losses in emerging markets.
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