The biggest performance dispersion among hedge funds and funds of funds in six years has set the stage for what some predict will be a six-month-long bloodbath.
Sources said they expect the body count to total as many as 2,000 hedge funds and 500 hedge funds of funds between now and the end of March as investors redeem assets from the poorest performers and weakest managers, and move into funds managed by strong, institutionally oriented firms.
Data from Hedge Fund Research Inc., Chicago, showed that for the 12-month period ended June 30, there was a 75 percentage point difference between the average performance of the industry's top and bottom deciles, said Kenneth J. Heinz, president. Further, Mr. Heinz said there was a heightened level of dispersion between managers in the same style categories. And to make matters worse, there was a performance dispersion of 37 percentage points between the average performance of top- and bottom-decile hedge fund-of-funds managers.
“These are the highest performance dispersion rates we've seen in the last six years,” Mr. Heinz said, noting that hedge fund returns within style categories and across the fund universe tended to be very closely correlated from 2002 through August 2007, a period characterized by low volatility, which pushed many hedge fund managers to add leverage to amplify their performance.
The witching hour is nigh, in fact, this week.
Most hedge funds operate on an end-of-quarter deadline for requests from clients to have their money returned. If experts' predictions of very large collective redemptions come true, managers will have to liquidate their holdings en masse, pushing down prices and forcing many smaller hedge funds or those with poor returns out of business. The wave of closures could span six months, likely beginning in earnest in November and December at the end of the typical 45- or 65-day waiting period when fund managers have to return investor cash. Sources said they think the pace of fund consolidation will wind down by the end of the first quarter of 2009.
“Consolidation in the hedge fund industry would not be the least bit surprising, but it's not the first time it has undergone consolidation and liquidation,” Mr. Heinz said. He pointed to HFR analysis of fund liquidation, which as of June 30 was on pace for 700 fund closures in 2008, up 24% from the 563 funds that closed in 2007, but well below the previous high of 848 funds in 2005.