Public RelationsPruned hedges
Hedge funds: Hedge funds are back in the land of the living. After a dismal 2008, they had a strong first half. Of course, rising markets aided them. But it helps that because of losses, withdrawals and, above all, a huge reduction in leverage, they wield only about a quarter of the nearly $10 trillion firepower they used to put to work. So trades are less crowded – and more profitable.
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Here’s how the arithmetic works. The peak for global hedge fund assets under management was $1.9 trillion in June 2008, according to Hedge Fund Research. Couple that with average borrowing of around $4 for every $1 of investor cash, and the industry’s firepower topped out just shy of $10 trillion.
Fast forward nine months to what looks like the trough this past March, and hedge funds managed some $1.3 trillion. Leverage seems to be down to perhaps one for one, according to Wall Street prime brokers – so the total investment by hedge funds has plunged more than 70 per cent to less than $3 trillion.
Crowded trades were one problem hedge funds faced before the credit crunch. Funds that specialise in exploiting inefficiencies in the market for convertible bonds, for example, had an uninspired 2007 and a particularly bad 2008. Market moves didn’t help, but overcrowding led to a dearth of real arbitrage opportunities, too.
Sharply reduced hedge fund firepower helps explain why this problem has waned. Convertible arbitrage funds are up 24 per cent so far this year, according to Credit Suisse/Tremont, against returns of 7 per cent for the typical hedge fund and 3 per cent for the S&P 500. Moves in debt and equity markets played a big part, but there have once again been mis-pricings to exploit and fewer dollars chasing them.
Hedge funds aren’t out of the woods – for one thing many, if not most, are some way off recouping last year’s losses and regaining investors’ confidence. Even so, the big picture is looking more cheerful for fund managers. Maybe they should keep in mind this time around that borrowing heavily and getting too large – individually, and as an industry – may not be good for them.