Hedge fund industry in good shape despite credit crisis

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“latest data on hedge fund performance reinforces early signs that the $1.8 trillion (£917bn, E1.2 trillion) sector can look back on the past 12, turbulent months with relief.”

Based on a database of around 7,000 funds (out of a global total of more than 11,000), Hedge Fund Research’s broad composite index of returns shows total average returns, after management fees are deducted, of 10.36% in the 12 months to 31 December. That just surpasses returns – based on reinvested dividends and share price gains – of 9.04% from the Morgan Stanley Capital International (MSCI) World Index of equities.
The ability to beat a broad market index (if only by one percentage point) is a reminder of why hedge funds have expanded so rapidly in recent years. They use leverage – punting on assets with borrowed money – and short sell equities to help earn steady returns over the long term, even in turbulent markets.

(Short selling is when a fund borrows stocks, sells them and then repurchases them at a cheaper price to make a profit.)

But performances such as this are unlikely to be good enough to allow hedge funds to continue charging their high fees, with criticism from the investment industry mounting last year. Hedge funds typically charge an annual management charge of 2% and a performance fee of 20% or more, considerably higher than traditional long-only funds.

Last year’s best performers were funds that focused on the emerging markets of Asia, chalking up total returns of 35.88%. Emerging market hedge funds as a whole, which embrace not just Asia but also Latin America and Eastern Europe, achieved an average return of 23.17%.

Energy-linked funds – which bet on sectors such as natural gas – were also notable high performers, with average returns of 16.47%. It is a stark contrast to 2006’s performance, which was dominated by the collapse of Amaranth, the American hedge fund that suffered heavy losses after incorrectly calling the natural gas market.

There were some black spots in 2007: funds that focus on financial services companies were hit as the sector was clobbered by the credit crunch. Here returns were negative, at -5.88%, which means investors lost money on their original capital.

So the hedge fund industry did not pass through 2007 unscathed by the credit turmoil. But this latest data demonstrates that the industry as a whole, having endured a torrid summer, is overall still in decent health.

Source: The Business | Wealth Management