Hedge This

Last week, we looked at the rise of the Hedge Fund. Today, we see two interesting Hedge fund articles, courtesy of the NYT and the WSJ.

The Journal looks at the demand side — why so many big institutions are putting money into Hedgies. By coincidence, the Times looks at the supply side — why so many hedge funds have popped into existence.

First up: Demand, via Steve Liesman, who discusses his experiences at a conference for a not-for-profit University endowment money.

The sessions on hedge funds were "standing-room only:"

"To understand the reason for the heightened interest, you have only to look at stock-market returns over the past several years. You’ll see a lot of negatives. Many of these endowments and pension funds are required to distribute some of their funds each year, to be used for scholarships or sports or endowed chairs. Negative returns on their investments mean they are cutting into principal. That just couldn’t last long.

They went searching not so much for higher returns as more even returns. "One of the reasons that pension funds are moving money toward hedge funds, is because they’ve now sort of changed their objective to producing a more consistent return year after year," says Bob Prince, co-chief investment officer for Bridgewater Associates, which has $115 billion under management and is one of the nation’s biggest hedge funds.

So what was attractive about hedge funds, then, was both higher returns and investments in alternatives that weren’t correlated to the stock market.

The demand for these hedge-fund services hit at just about the same time that there was an increase in supply for those who would offer them. Recall the two critical investment mantras from the 1990s: that markets were instantly efficient and couldn’t be beaten and, therefore, the best way to invest was to buy and hold. Along came "benchmarking" which acted like a ball and chain around the necks of investment managers. Beating the benchmark became the be all and end all. And the best way to beat or at least match the benchmark was to hold a preponderance of the securities in that benchmark index."

The demand is there. And why the supply? Well, perhaps this has something to do with it:
click for larger graph

Hedge

 

Its not just the top performers; The NYT explains the details:

"The secret to the wealth of hedge fund managers is how they get paid. Instead of receiving a fixed percentage of the funds they manage, as mutual fund managers do, hedge fund managers generally make "1 and 20" – 1 percent of assets under management and 20 percent of profits.

That means that a $1 billion hedge fund manager earns $10 million just for opening the doors, and a lot more if his fund performs well. Investors are willing to pay more for these managers’ talents because, at a time when stocks are doing poorly and yields on short-term Treasury securities are low, hedge funds hold out the hope of a better return."

Indeed.

Source:
Hedge Funds Are Taking Roles of Jekyll and Hyde in Markets
Whether Passing Fad or Permanent Shift, Supply, Demand Bring Them to Fore
Steve Liesman
WSJ, May 27, 2005
http://online.wsj.com/article/1,,SB111713947456744350,00.html

Hedge Funds Are Stumbling but Manager Salaries Aren’t
RIVA D. ATLAS
NYT, May 27, 2005
http://www.nytimes.com/2005/05/27/business/27hedge.html

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