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HEDGE FUNDS START TO FEEL THE IMPACT OF THE POOR RETURNS OF FINANCIAL ASSETS
 
The statistical analysis of the data from the 2003 edition of The U

The statistical analysis of the data from the 2003 edition of The U.S. Offshore Funds Directory published last month shows a considerable slowdown from the explosive growth of the 1999-2001 period. In the post-bubble period with equities producing three consecutive down years and interest rates declining to levels where real rates are negative, hedge fund investors have had to come to grips with the reality of the decline of returns from financial assets. The capital-weighted rate of return of offshore hedge funds continued to show a positive 3.2% number in 2002. However, most investors who incur additional costs (such as funds of funds fees, friction costs due to lags in subscription and redemptions and survivorship bias costs) would have been better off to stay in Treasury bills. Overall net money flows into offshore hedge funds continued to be healthy in 2002, representing 11% of the capital at the beginning of the year. Fifty-four percent of the funds registered positive net inflows. The decline in overall returns since the 1999 peak has caused a slowdown in hedge fund creation and an increase in hedge fund closures (12% of funds in existence at the beginning of 2002 closed last year), resulting in the number of hedge funds growing by only 5% in 2002, the lowest growth rate since we began compiling this data in 1990.

2003

2002

2001

2000

1999

Single Manager
Funds @BOY

779

737

647

609

494

Capital @ BOY
(in $ billion)

$166.8

$150.4

$117.6

$113.0

$76.7

Funds with BOY
capital >$100M

284

265

204

164

122

5 largest funds
as % of total

17.0%

15.3%

16.6%

20.5%

24.4%

Funds opened
during year

124

171

140

200

Funds closed during year

86

58

58

49

Capital weighted
rate of return

3.2%

5.9%

7.1%

25.8%

While slowdowns often follow periods of explosive growth, as occurred in 2000, recent developments point to a different path this time, in spite of overall asset growth. In 2002, the continuing institutionalization of the investor marketplace and the decline in overall returns caused investors to become much more cautious in allocating funds to new managers and even quicker in pulling assets from poor performing managers.

Offshore Hedge Funds vs. S&P 500
Annual compound rate of return over calendar years
(weighted by capital at the beginning of each year)

1 year

3 years

5 years

10 years

Hedge Funds

3.2%

5.4%

8.4%

13.5%

S&P 500

-22.1%

-14.6%

-0.6%

9.3%

We have seen more examples than before of funds opening and closing within a two year period. Also in 2002, concentration of capital among the largest hedge funds stopped declining for the first time, altering the year after year trend of the past dozen years. In 2001, we had noted the wide discrepancy between the 18% asset growth among the 50 largest hedge funds vs. the 28% asset growth in the larger sample of funds in The U.S. Offshore Funds Directory. In 2002, asset growth from both sets of data was virtually identical at 11%, indicating that capital did not flow as easily to smaller funds as before. Renewed interest for macro and relative value trading strategies has generally favored larger funds than the typically more capacity constrained long-short equity funds. Only very large funds are able to accept the $100 million allocations that institutional investors and large funds of funds now look for. All this points to a maturing of the hedge fund market as well as potential consolidation. One may wonder if these trends may not be adverse in the long run to the outstanding performance delivered by hedge funds when they catered to a more entrepreneurial investor base.
u

Offshore Hedge Funds
Industry Structure

(as of 1/1/2003)

Category of fund size

% of number of funds

% of total capital

Average size by category (in $M)

<$100M

64%

9%

32

>$100M and <1,000M

33%

48%

304

Over $1B

3%

43%

2,687

 
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