By some measures, 2008 was one of the darkest periods in the history of the hedge fund industry.
The immediate impact of the global financial meltdown could trim the overall size of the hedge fund industry 30% to 50% over the next several months, as investors flee and some strategies implode.
The good news, however, is that once the dust finally settles, the wreckage of 2008 could lay the foundation for a promising and prosperous 2009.
"Hedge funds have a tremendous opportunity ahead of them and [this] year has the potential to be a very strong year for the industry," said Meredith Jones, managing director at PerTrac Financial Solutions LLC, a New York-based research firm.
Ms. Jones, who acknowledged the long list of challenges facing the industry, from increased regulatory pressure to fee compression, pointed out that most strategies still stack up quite respectably to the broader equity markets.
Through the end of November, the Hennessee Hedge Fund Index was down 18.4%. This compares to a 38.9% drop by the Standard & Poor's 500 Index over the same period.
"In general, the performance of hedge funds has been vastly superior to what you're seeing out there and, as a result, more pensions, endowments and foundations are looking at hedge funds," Ms. Jones said. "People who have never even been in the hedge fund space are now starting to discuss hedge fund investments."
Greg Friedman, chief investment officer at Greycourt & Co. Inc., a Pittsburgh-based advisory firm that manages $9 billion for mostly wealthy clients, anticipates an industrywide evolution.
"There has been such demand for hedge funds that it created a supply-and-demand imbalance to the point where over the past three-to-five years the good hedge funds could charge whatever they wanted," he said. "Going forward, you're going to see a leveling off in terms of everything from lock-up periods to fees to the right to replace general partners to account minimums."
In terms of regulatory oversight, particularly under a new presidential administration, Mr. Friedman said he would not be surprised to see a bifurcated hedge fund industry emerge, where those funds working with institutional investors would be subject to greater scrutiny than those managing money for wealthy individuals.
While market pressures have already shrunk the industry down to roughly 9,700 funds and $1.5 trillion, from a peak of roughly 10,200 hedge funds and nearly $2 trillion, the final numbers for 2008 could add up to an even leaner industry in 2009.
Subpar performance and an overly skittish investor base deserves some of the credit for the shrinkage, but outside forces have also played a part in making it more difficult for hedge funds to succeed, according to John Van, Nashville-based chief compliance officer for Greenwich Alternative Investments LLC in Stamford, Conn.
"Leverage, hedging and liquidity are all things that make hedge funds unique, and those things are all being taken away from hedge fund managers," he said, citing the impact of the credit crunch, a government-imposed ban on short-selling and pressure from investors for greater liquidity and redemption rights.
"It's been a challenging market and I anticipate about a third of all hedge funds and half the industry assets will disappear," said Raju Panjwani, founder and chief executive of Epitome Global Services, a New York-based firm specializing in back-office outsourcing for hedge funds. "I think much of the hedge fund industry will morph into the private-equity business."
But the industry is far from ready to roll over and die, according to Richard Baker, president and chief executive of the Managed Funds Association in Washington.
"I don't think some of the presumptions about our industry are very well founded and I don't think the way we do business is in jeopardy," Mr. Baker said. "There will be some contraction in the hedge fund industry, but the consequences of this market will be less severe on us than that of the overall market, and our recovery period will be shorter."
E-mail Jeff Benjamin at [email protected].
