The flow of money into hedge funds slowed to $9.4 billion in the third quarter, down from $10.9 billion in the second quarter and $16.9 billion in the year-ago period, Hedge Fund Research reports. Considering the industry's breakneck growth, a cooling off is probably a good thing. What's not so good is that during the same quarter, funds of funds saw outflows of more than $1.2 billion, compared with inflows of $3.5 billion in the second quarter and $6.2 billion a year ago. Joshua Rosenberg, president of HFR, attributes those results to hedge funds' poor performance. But reports of shoddy due diligence around a couple of high-profile blowups probably didn't help. Funds of funds are pools of funds managed by people whose job is to select the best managers and to eliminate the bad apples or poor performers. When such managers fail to do their job, they can have trouble holding on to customers. That may be what has happened here, with investors getting more and more skittish in the face of scandals such as those that ripped Bayout Capital and Wood River. Funds of funds also saw their legitimacy fiercely criticized last week. David Swenson, the chief investor officer for Yale and one of the most sophisticated hedge fund investors there is, slammed the industry in a New York Times op-ed piece. Swenson argued against the existence of financial intermediaries on whom less-informed investors rely, and urged the tightening of the rules governing who is allowed to invest in hedge funds. "As it is often the case with financial excesses, what began as a resonable opportunity for sophisticated investors has become a killing ground for naive trend-followers, with scandals and frauds prompting predictable calls for increased regulation," Swenson wrote. "But if Congress and the Securities and Exchange Commission really want to protect individual investors, they should prohibit unsophisticateed players from participating in hedge funds."
The U.S. equity market continues to spook many investors, including hedge funds. In a research piece, Merrill Lynch analyst Cam Hui says that hedge funds have been reducing exposure to U.S. equities, even as the industry's ratio of long to short bets held steady. In other words, hedge funds have apparently been shorting their U.S. stocks while buying equities overseas. "Managers are seeking different markets with better returns outside of the U.S. and in many cases they are reducing or selling their exposure to the U.S.," said Richard Bookbinder, founder of New York-based fund of funds Bookbinder Capital Management.