New Game Awaits Humbled Hedgies

The hedge fund era as we have known it may have come to an end, with returns evaporating, clients demanding their money and officials eager to tighten regulation, but experts say the industry is poised to emerge stronger once it consolidates, cleans up shop and opens the blinds.

While hedge funds are not required to publicly disclose much information, the industry stands to book its first year of negative performance since private groups first started tracking data about a decade ago. Hedge fund investments lost 22% of their worth through November, according to BarclayHedge, which collects data from around 2,200 funds. In light of the unprecedented turmoil and huge market shifts from day to day, few were nimble enough to avoid losses, leaving hardly any portfolio unscathed.

Compared with the broader market, whose indices lost closer to 40% over the same period, one could argue that hedge funds are still outperforming. But that argument, and promises of better days, provide little solace for clients paying alpha fees for alpha returns. As clients watched the Bernard Madoff scandal unfold, even the most trusting and daring started to demand their cash.

Many hedge funds have responded by putting "gates" around assets so that investors must wait for a period before withdrawing funds. That strategy might buy time, but it won't solve the problem.

"Once the gates come up, people will withdraw anyway, so it's kind of delaying the inevitable," says Pierre Villeneuve, managing director of the quantitative hedge fund Mapleridge Capital.