Growth Rate Slows, But Still Steady
The hedge fund universe expanded for the tenth straight year in 1998, with an estimated 330 new funds created, George P. Van, chairman of Van Hedge Fund Advisors International (VAN), a leading hedge fund investment advisory firm reported today.
“In 1998, we estimate that over 300 new hedge funds were formed, bringing the total number of funds to 5,830 worldwide,” said Van. “While this is still a healthy number of new funds, it does indicate some slowing in hedge fund growth. In 1996 and 1997, for example, the number of funds increased by approximately 9% and 8% respectively, while in 1998, the number of funds increased by about 6%. In addition, the increase in hedge fund assets slowed in 1998, with total equity under management growing to an estimated $311 billion. This represents a net increase of over 5%, compared with 1997’s more robust 13% gain and 1996’s leap of 20%.
“The reasons for this slowdown are fairly straightforward. Last year was marked by significant volatility resulting from the Asian crisis, Russia’s default on its debt, short-term investor panic, and the Fed’s swift action to resist global and domestic recessionary forces. In the third quarter we saw a highly unusual ‘flight to quality’ which severely impacted equity, credit and bond markets, resulting in double-digit losses for most investment vehicles,” noted Van. “In addition, in 1998 the Long Term Capital Management debacle cast its shadow over hedge funds, as did well-publicized losses by many of the ‘name’ funds, including both Soros’s and Robertson’s flagships. Despite all these events, including an extremely difficult third quarter, the average U.S. hedge fund gained 11.7% net in 1998, while the average Offshore hedge fund posted a slight loss of -1.5% net.
“Following the third quarter market problems and negative hedge fund press, the industry expected significant year-end redemptions by hedge fund investors seeking ‘safer havens’ such as U.S. Treasuries. This run on assets didn’t occur, however, because investors were reassured by a strong fourth quarter showing by hedge funds as well as widely disseminated information on actual hedge fund practices. For example, investors learned that the degree of leverage employed by Long Term Capital Management was highly exceptional. They also learned that the typical hedge fund is not capable of influencing markets by virtue of its relatively small size compared with the investment portfolios of large banks, brokerage houses and insurance companies,” Van continued.
“1998 was a watershed year for hedge funds, and 1999 so far has proven to be a whole different ball game. Year to date through August, the average hedge fund was well ahead of both the S&P; 500 and its own performance for the full year 1998. Where last year we saw losses in funds specializing in mortgage-backed securities, this year we have seen strong gains, despite spreads approaching their 1998 levels. Macro and Emerging Markets funds, which last year performed poorly in an unstable environment, are some of 1999’s strongest performers, despite the devaluation of the Brazilian currency and economic tremors throughout Latin America.
“The improvement in hedge fund performance is attributable to several factors,” said Van. “First, lower leverage, particularly in market neutral strategies like mortgage-backed securities, has lowered their volatility and, with smaller positions, has enabled them to move more nimbly. Second, many funds have increased their hedging, no longer lulled into complacency by a seemingly endless bull market. And finally, global economic recovery also has helped.
“Overall, the climate for new and existing hedge funds was good for most of 1998 but it has improved further this year. With the U.S. government’s having not yet imposed new hedge fund regulations in the wake of LTCM and the strong performance of hedge funds thus far in 1999, we are seeing the number of funds increase yet again in 1999,” Van concluded.