The three hedge funds liquidated by Lipper & Co. are the first significant failures in the hedge fund world since the collapse of the Internet bubble, the onset of the bear market and the Sept. 11 attacks.
The liquidations came after several commentators warned the surge in new hedge funds, and the booming demand for such funds, could signal the development of a hedge fund bubble.
The Lipper fund liquidations could have signaled the beginning of a period of trouble for hedge funds. So far, however, they appear to be simply a sign of poor decision-making at one firm, and in one category of hedge funds: convertible arbitrage.
In fact, considering the collapse of the Internet bubble, the resulting decline in the stock market (high-flying Internet and tech stocks in particular) and the mostly sideways movement in the market since then, hedge funds as a group have performed remarkably well. On average they have outperformed the indexes and long-only active managers.
In effect, they have, by and large, lived up to their name, hedging enough of the risk in their investments that they outperformed their non-hedge fund competitors.
Even though most hedge funds are hedged to some degree, some use leverage at least some of the time. It is surprising that more were not caught on the wrong foot when the bear market began, that there weren't a few more problems.
Indeed, one might have expected the news of the problems with the Lipper convertible arbitrage funds to have a significant impact on the convertible arbitrage sector of the hedge fund market, considered by some to be the most risky in the hedge fund arena at present.
The collapse of the funds meant a significant number of securities would be dumped on the market. In addition, because the Lipper problem involved valuation of illiquid securities, it could have raised questions in the minds of investors about other such funds. That apparently has not happened.
One reason the fallout has been minimal, according to Virginia Reynolds Parker, president of Parker Global Strategies, is that many hedge funds were adjusting their positions and valuations throughout the summer and fall of 2001.
"The markets had been difficult before Sept. 11," she said. "Fund managers had made changes. Fixed-income arbitrageurs had improved their (portfolio) quality. Long-short managers had very light positions." That is, the veteran hedge fund managers managed.
Ms. Parker, whose firm has advised institutional investors on the placement of $1 billion in assets with hedge funds, believes that despite the burgeoning number of new hedge funds, traditional long-short equity hedge fund managers still can find alpha. "Good stock pickers should be able to achieve attractive returns over the long run," she said.
"Where you have a bigger problem is in some of the arbitrage strategies, such as merger arbitrage, where the spreads on deals have become very narrow." She said her firm has reduced its allocations to convertible arbitrage and merger arbitrage.
Another problem area, she said, is that a lot of experienced hedge fund managers, such as George Soros, Julian Robertson and Jeffrey Vinick, have retired, or at least closed their doors to outside investors. "A lot of experienceis gone," she said.
One area Ms. Parker believes is still a potential problem is the lack of transparency, the lack of disclosure about what is in hedge fund portfolios. The situation is improving, she said, in part because more traditional institutional managers are entering the hedge fund business, and they are used to the levels of disclosure demanded by pension funds. They are more willing to disclose.
Ms. Parker said she is working with another group, which she declined to name, to put together a group of long-short equity hedge funds into a fund with daily liquidity.
If Ms. Parker and the others involved can make the idea work, it would be yet another sign of the growing maturity of the hedge fund business, a maturity hinted at by what so far has been an impressive response to the events of the past two years.
