BOSTON -- Investors have short memories when it comes to hedge funds.
After above-average redemptions in 1998 -- following the meltdown of Long-Term Capital Management LP -- the first six months of this year saw a turn-around in investor interest, according to a new report by Cerulli Associates Inc., Boston. Hedge fund assets grew 14% to $355 billion in the first two quarters, putting this year on track to break records for new hedge fund sales.
In contrast, hedge fund assets increased only 5.4% in all of 1998, ending the year with $311 billion in total.
Hedge fund performance was the primary driver behind a surge of investment by both retail and institutional investors, said the authors of "Market Update (1999): Hedge Funds." By one measure -- the Hedge Fund Aggregate index -- industry performance was up 15.34% year-to-date as of Aug. 31, compared with 8.3% for the Standard & Poor's 500 index.
Institutional investors have proven they aren't immune to the lure of hedge fund vehicles: About 25% of the money invested in hedge funds is institutional, up from just 5% six years ago. Tax-exempt pension funds have invested an estimated $28.4 billion in hedge fund vehicles, and endowments and foundations have invested $21.3 billion, according to data from Cerulli.
Cerulli consultants predict many more pension fund investors will follow the lead of the $160 billion California Public Employees' Retirement System, which made a first commitment of $300 million to a hedge fund in September, seeking an asset class with less correlation to the capital markets.
If the popularity of hedge funds continues, institutional investors quickly may run into hedge fund capacity problems, since the Employee Retirement Income Security Act mandates that no more than 25% of a hedge fund's assets can be ERISA qualified.
That capacity constraint may be magnified by a recent slowing of new hedge fund introductions, according to the report. There are now an estimated 6,100 hedge funds worldwide, but growth slowed to less than 5% in the first six months of 1999, and growth for the year is estimated to be between 8% and 9%. During the early 1990s, new hedge fund introductions were growing at a rate of 20% per year.
The average size of hedge funds is leveling off, Cerulli staff found, a sign of "a maturing industry, with more funds meeting and adhering to pre-set capital limits. Unlike mutual funds, which rarely close to new investors and are always focused on attracting assets, hedge funds are limited partnerships that are designed to grow to a certain point, then close to new investors," the study noted.
In 1998, the average hedge fund had about $30 million under management. Growth was steady until 1993, when the average fund size peaked at about $50 million. From 1995 to 1998, new funds with lower minimum investments increased competition, which dropped the overall average, according to the report. For the past five years, the average hedge fund size has varied between $46 million and $53 million. In the first two quarters of 1999, that number swelled to $58 million, an all-time record.
These lower average fund sizes correct the popular image of hedge funds as multibillion dollar megaliths. Cerulli's data analysis showed 84% of hedge funds have less than $100 million in unleveraged assets. Only 2.5% of U.S. hedge funds manage more than $500 million in unleveraged assets.
The common perception of overleveraging within hedge funds is also resolved by a look at the data. The report showed only 36% of hedge funds use any leverage in their investment strategies, and of the funds that do, 85% do so only up to a two-to-one ratio.
A slight majority -- 52.3% -- of U.S. hedge funds have an equity focus, compared with 48.5% of global hedge funds. About 40% of U.S. hedge funds invest in a mixture of asset classes, while 4.7% of hedge funds invest only in bonds, 1.9% exclusively in derivatives, 2.4% in only futures and 2.2% in mutual funds.
The Cerulli hedge fund report found value strategies are the most prevalent for U.S. hedge funds, 936 funds; followed by opportunistic funds, 472; aggressive growth funds, 468; and funds-of-funds, 452.