Glory days are fading fast for the gilded hedge funds

Published 5:00 am Friday, September 12, 2008

Making millions — or even a few billion — by managing a hedge fund has been a running dream on Wall Street in recent years. But suddenly even the masters of this $2 trillion universe are falling on hard times, at least by their own gilded standards.

Hedge funds, those secretive investment vehicles for the rich and, increasingly, not-so-rich, are supposed to make money whether markets go up or down. But many of them are being swept up in the turmoil of the financial world.

The funds’ investment returns are sinking, and so are those big paydays for their managers, whose riches have helped redefine our notions of wealth and helped drive up the price of everything from Picassos to Manhattan penthouses.

Several big funds have faltered in recent weeks, some of them spectacularly so. While many funds are still flying high, the average hedge fund has lost more than 4 percent this year, according to Hedge Fund Research, putting the industry on course for its worst year on record.

The dimming fortunes of the industry have implications far beyond the rarefied world of hedge funds. Over the past decade, the size of this industry grew five-fold, as public pension funds, corporate pension funds and university endowments poured billions of dollars into these vehicles, in hopes of market-beating returns.

A prolonged downturn might prompt some investors to rethink these investments or demand lower fees from managers, who typically collect annual management fees of 2 percent and then take a 20 percent cut of any profits. Trouble at hedge funds also might draw government scrutiny, given the amount of pension money sitting within these unregulated firms.

While big hedge funds have blown up in the past, and many small ones go under every year, the current problems are more far-reaching than they have been in the past. Fund after fund is warning investors that the markets have become increasingly difficult to predict.

They are having a tougher time making money now that Wall Street banks like Lehman Brothers, which is in an all-out fight for survival, have reduced the amount of money they are willing to lend to the funds in order to safeguard themselves. It is now 5 to 10 percent more expensive for hedge funds to borrow from banks than it was a year ago, and banks are increasingly hesitant to lend to hedge funds for long periods.

In recent weeks, several funds have closed, most notably a fund run by Ospraie Management. Rumors about troubled hedge funds like Atticus Capital have unsettled the broader markets.

“I think we’re seeing what these hedge fund managers really, truly are,” said Robert Discolo, head of hedge fund strategies for AIG Investments, an asset manager within the insurance giant AIG. “And some of them really can’t make money in a difficult environment.”

Already, hedge funds are planning for harder times ahead. Fund managers are planning to slash employee bonuses in December, according to a study to be released this week by Glocap, a hedge fund recruiting firm.

“This is probably one of the worst years for performance of hedge funds — it’s been a blood bath,” said Adam Zoia, the chief executive of Glocap, which began tracking hedge fund compensation in 2001 and has never recorded a down year until now.