Hedge Funds Lost Record 18.3% on Misjudged Markets

Hedge Funds Lost Record 18.3% on Misjudged Markets

Jan. 8 (Bloomberg) -- Hedge funds lost 18.3 percent in 2008, their worst year on record, as managers misjudged the severity of the biggest financial crisis since the Great Depression.

A gain of 0.42 percent in December lessened the average loss for the full year, according to Hedge Fund Research Inc.’s HFRI Fund Weighted Composite Index. The decline was the largest since the Chicago-based firm began tracking data in 1990.

“Hedge funds failed to appreciate the magnitude, breadth and duration of the declines we saw across most markets,” said Michael Rosen, principal at Angeles Investment Advisors LLC in Santa Monica, California, which advises clients on investments.

Investment losses and client withdrawals reduced industry assets to $1.1 trillion last month from its peak of $1.9 trillion in June, according to Morgan Stanley. Firms such as Dwight Anderson’s Ospraie Management LLC and Jeffrey Gendell’s Tontine Associates LLC closed funds, while Paul Tudor Jones’s Tudor Investment Corp. and Kenneth Griffin’s Citadel Investment Group LLC were among those to limit redemptions.

The decline by hedge funds last year compared with the 37 percent drop in the Standard & Poor’s 500 Index, including reinvested dividends, the benchmark’s worst showing since 1937. Commodities slumped 33 percent, according to the UBS Bloomberg Constant Maturity Commodity Index of 26 contracts.

The worst previous performance by hedge funds was in 2002, when they lost 1.45 percent while the S&P 500 tumbled 23 percent. Hedge funds returned 9.9 percent in 2007.

Stock Funds Lose

Among the major investment strategies, equity hedge funds lost the most last year, an average of 26 percent, Hedge Fund Research said. Event-driven funds, which invest in companies going through changes such as mergers and spinoffs, lost 21 percent. Macro hedge funds, which can bet on securities from commodities and interest rates, returned 5.7 percent.

Tontine, based in Greenwich, Connecticut, was among the firms with the biggest losses. Tontine Partners LP fund slumped 91.5 percent, while Tontine 25 Fund lost 64 percent, according to investors. Griffin, 40, who runs Citadel, lost about 53 percent from its two biggest funds. The Chicago-based firm oversees $13 billion.

Executives at the firms declined to comment.

Last year’s winners include Paulson & Co., run by John Paulson, 53. The New York-based firm, which manages about $36 billion, posted a 37 percent gain in its Advantage Plus Fund Ltd., according to investors.

Brevan Howard

Brevan Howard Asset Management LLP, Europe’s biggest single-manager hedge-fund firm, produced a 22 percent gain in its main fund, the $15 billion Brevan Howard Fund, investors said. London-based Brevan, founded by Alan Howard, 45, oversees $26.4 billion.

Ionic Capital Management LLC, a $3.9 billion fund run by former Highbridge Capital Management LLC executives Bart Baum, Adam Radosti and Dan Stone, returned about 20 percent last year, investors said.

“This is a Darwinism moment for the hedge-fund industry,” said Amit Shabi, a partner at Geneva-based Bernheim Dreyfus & Co., which invests in hedge funds. “Investors will be taking note of the managers who were able to preserve capital in 2008. They will form the core of the industry in the future.”

Managed futures funds, which rely on computers to decide when to buy and sell securities, outperformed peers in 2008 after betting against stock markets and correctly betting on the direction of commodities.

Futures Funds

Winton Capital Management Ltd., the $13.3 billion London- based firm started by David Harding, 47, generated a 21 percent return in its $5.5 billion futures fund. Tudor’s $1 billion futures fund, Tensor, returned 36 percent last year.

Banks restricted the amount of money they loaned to hedge funds as credit markets froze, while funds cut investments and held cash to avoid losses. Funds held more than $300 billion in cash, according to a December report by Man Group Plc in London.

RAB Capital Plc, based in London, and New York’s GLG Partners Inc. were hurt when some of their assets held in the European prime brokerage unit of Lehman Brothers Holdings Inc. were frozen after the New York-based investment bank filed for bankruptcy in September. The Lehman division provided lending and brokerage services to hedge funds.

Market losses in the second half of the year led funds to limit investor withdrawals. Tudor, run by Jones, 54, out of Greenwich, Connecticut, told investors in November that it would suspend withdrawals until the end of March. Citadel and Harbinger Capital Partners, which is run by 46-year-old Philip Falcone, last month restricted redemptions.

Funds of Funds

Funds that invest in hedge funds lost 20 percent last year, Hedge Fund Research said. Tiger Select Absolute Return Fund LP, a fund of funds overseen by Morgan Creek Capital Management LLC in Chapel Hill, North Carolina, lost 51 percent in the first 11 months of the year, according to an investor letter.

“They’ve shown not to have added any value above the broad market,” James McKee, director of hedge-fund research at Callan Associates Inc., an investment consulting firm in San Francisco, said of funds of funds. “I don’t think it will be the death of the fund-of-funds industry, but there will be a lot of pressure for change.”

Madoff Impact

The industry was hit by the alleged fraud by Bernard Madoff, who last month confessed to employees that his investment company was “a giant Ponzi scheme,” that may have cost clients as much as $50 billion, according to an FBI complaint. In a Ponzi scheme, early investors are paid with money from subsequent participants rather than from actual investments.

The hedge-fund units of Spain’s Banco Santander SA and Geneva-based Union Bancaire Privee were among those that had invested in Madoff.

“Recent events will unavoidably lead to a re-evaluation of the hedge-fund model,” Man Group said in the report. “The concept of absolute returns, once a key selling point for the industry, will have to be revised in light of recent losses.”

About 6.9 percent of the industry, or 693 funds, closed in the first nine months of 2008, Hedge Fund Research said. For the whole year, 920 funds may have been shut, topping the all-time high of 848 closures in 2005, the firm said.

Ospraie’s Anderson, 41, closed his flagship $2.8 billion fund in September because of losses in commodities. Gendell said in November it would start liquidating two of its four hedge funds.

Carlyle Group, the private-equity firm run by David Rubenstein, 59, began closing its Blue Wave hedge fund in July. Arience Capital Management LP and Sunova Capital LP, both based in New York, also liquidated funds.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

BLOOMBERG