From Today’s FT
June 3, 2009
I have been talking about the evolution of the industry for some time.
I have pulled out the last 4 paragraphs. Excellent summary of the state of the industry and the path forward.
From 2002 until late 2007, a growing wave of capital, combined with a five-year upwardly trending market, fuelled a massive expansion of the industry from about 4,000 funds and $700bn of assets to almost 8,000 funds with nearly $2,000bn of assets. At the same time, hedge funds became highly correlated with equities as many managers relied too heavily on rising markets to generate returns, with disastrous consequences in some cases.
But one should recognise that some hedge funds did profit and meet expectations in 2008. These managers (largely macro and managed futures strategies) had often not been the best performers in the bull market because they controlled risk and correlation and so were often overlooked. Their time has come because they have shown an ability to offer a non-correlated return, which provides important portfolio diversification.
So, while 2008 was very painful for most hedge funds, it is unlikely to herald their demise. There will always be investors seeking absolute returns with low correlation to equity markets and low volatility. As the losses incurred by many hedge funds last year show, it is difficult to achieve all these simultaneously. But firms with investment talent, strong research capabilities, and appropriate due diligence and risk management are discovering a wealth of opportunities as they develop a better understanding of the financial crisis and adapt accordingly. The positive returns achieved by many hedge funds so far this year suggest that a rapid evolution is taking place.
The huge amount invested in hedge funds between 2002 and 2007 brought the industry to maturity quicker than expected. This maturity is likely to lead to a refocusing of priorities as funds return to their original purpose of hedging risk and protecting against market falls. Ultimately, that is the method by which they may generate consistent absolute returns.