Wealthy Americans Lose Money as Hedge Funds Get Hammered

BOSTON (TheStreet) -- Hedge funds, now mostly in capital-preservation mode, tumbled last month, underscoring the view that there's nowhere for investors to hide as the U.S. economy crumbles and Europe's woes deepen.

Hedge funds, which manage money on behalf of wealthy investors and institutions such as pension funds, fell 4.2% in September, bringing losses for the year at the end of the third quarter to 7.8%, according to the Dow Jones Credit Suisse Hedge Fund Index. The benchmark S&P 500 Index, in comparison, declined 14.3% through the end of the third quarter, with half that coming in September.

The third quarter represents a sharp turnaround from hedge funds' average 1.7% gain through the end of the second quarter. Still, they're seeing inflows this year as investors see such funds as one way to spread their risk, since their performances are less correlated to that of the equities markets and because there are few other options right now.

Another hedge fund index, the HFRI Fund Weighted Composite Index, reported a 2.8% decline in September for the hedge funds it tracks, bringing losses for the quarter to 5.5%. That's the fourth-worst quarterly decline in industry history, trailing only the third and fourth quarters of 2008 and the third quarter of 1998.

"Intense volatility negatively impacted nearly every area of financial markets and the hedge fund industry in September, as weakness was both pervasive and widespread," said Kenneth Heinz, president of Hedge Fund Research (HFR), which manages the HFRI index, in a press release.

He cites the ongoing European sovereign debt crisis as one of the key culprits in raising markets' volatility and investors' flight to safer asset classes, which served to work against hedge funds performances.

Given that environment, "fund managers are positioning for continued volatility and opportunities created by dislocations across asset classes," he said.

Oliver Schupp, president of Credit Suisse Index Co., which is co-manager of the Dow Jones Credit Suisse Hedge Fund Index, said that compared to the 15.4% drop this year of the broader Dow Jones Global Index, "hedge funds have provided some level of capital preservation. However, all strategies appear to be feeling the pain with market uncertainty at an all-time high."

That index tracks 9,000 funds with assets of at least $50 million.

Despite their losing performances, investors have continued to put money into hedge funds, including $6 billion in August, based on data from the 2,762 funds tracked by TrimTabs Investment Research, which is the latest such data available.

July, when investors yanked $9.3 billion out of hedge funds, was the only month this year that hedge fund saw outflows, and they have had inflows in 16 of the past 19 months, TrimTabs said.

TrimTabs analyst Leon Mirochnik told TheStreet that institutional investors, including pension funds and endowments, are continuing to use hedge funds as a means to diversify their portfolios, since have little correlation to the equities markets and because they offer better relative returns.

For the year through the end of August, hedge funds saw inflows of $51 billion, about on par to the $52 billion they saw for all of 2010, he said.

"They are struggling with underperformance, but investors are still giving them money, so hedge funds could be a bullish indicator for the markets, since they have a lot of money to invest," Mirochnik said.

Net assets of hedge funds, at just under $2 trillion, are flat to the start of the year, he said. That statistic is influenced by investor fund flows as well as investment performance.

Roughly 60% of hedge fund investors are institutional funds, and they are also used by financial advisers as alternative investment vehicles for retail or wealthy clients.

Multi-strategy funds, which allow managers wide latitude in their investment choices, gathered the most, at $2.1 billion, followed by fixed-income-focused funds at $840 million, HFR said.

The best-performing hedge fund strategy this year has been for those in the private issues category, which is up 7.8% to Sept. 30, followed by the short-bias index category, up 6.7%, HFR said. The worst performance was by the energy/basic materials sector, which lost 15.5%.

Given that it appears that some hedge funds are now looking at probable double-digit losses for the year, some of their managers are going to see a down year for their personal earnings. They typically collect a performance fee of 20% of the fund's profits during any year on top of a management fee of 1% to 2% of assets.

Readers Also Like:


Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

More from Personal Finance

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

Preferred Stock & Common Stock: What's the Difference?

Preferred Stock & Common Stock: What's the Difference?

How to Buy a Stock

How to Buy a Stock

How to Open a Brokerage Account

How to Open a Brokerage Account

What Is Shane Smith's Net Worth?

What Is Shane Smith's Net Worth?