Private investors are being squeezed out of the industry, which is now dominated by institutions.
The world’s super-rich will soon become marginal financiers in the hedge fund industry as the business they invented is increasingly dominated by large institutional investors, fund managers say.
Billionaires and other individuals rich enough to spend most of their time nurturing their bank accounts are still pouring more money into the industry, which uses sophisticated financial strategies to aim for high and sustained returns.
But inflows from pension funds, endowments and companies are rising faster, reducing private investors to a minority now that the industry, at an estimated $1 trillion of assets, has become sizable enough to swallow institutional investments.
Just five years ago, the overwhelming majority of the then-$500 million of assets managed by hedge funds were from wealthy individuals, said Tanya Styblo Beder, who runs a hedge fund called Tribeca Global Management LLC.
“If we go forward to the year 2010, it’s estimated that 80 percent of the assets under management in the hedge fund will be from institutions. So it’s a big switch that’s happening,” she said. Tribeca manages $1.5 billion for Citigroup.
Hedge funds first became popular as early as the 1960’s, when wealthy individuals used innovative financial tactics like short-selling and leverage to create returns they could not match in conventional trading.
Research confirms that such investors are no longer in the majority, with data provided by IFS, a U.K. financial lobby, showing 44 percent of the assets in the industry came from wealthy people in 2004, down from more than 60 percent in 1996.
The difference is even more telling when looking at inflows into hedge funds—a more precise measure of investor appetite. In 2004, institutions signed up for roughly 30 percent of inlows, a number expected to rise to 50 percent by 2008.
Bull market blues
Less sophisticated private investors may have lost interest in hedge funds, however, as the sector has shown meager returns in the last two years, with bullish equity markets pre-empting the need to hedge against bear markets.
Such high net worth individuals typically still have millions to look after and were often lured into buying alternative investment products by their banks in the heyday of the industry just a few years ago.
“You’ve seen some sub-optimal returns in 2004, some hiccups in 2005. Those clients are now thinking, hold on, that’s not what I was told about hedge funds,” said Jonathan Wauton, who leads Liberty Ermitage, a New Jersey-based hedge fund.
Private investors are typically more fickle than institutions, fund managers say, shifting assets rapidly in search of higher returns.
“Interest in hedge funds certainly from a private client perspective is waning, because they see that there are again decent returns to be made in equity markets,” says Stan Beckers, a hedge fund manager at Barclays Global Investors.
October was the worst month for hedge fund performance since August 1998, Eurohedge said recently, and analysts say funds’ returns in the first half of the year were nearly flat. Last year, the industry failed to match 2003’s solid returns.
Hedge funds ask for hefty fees in return for beating stock market indices on a sustained basis, often charging 2 percent of assets under management a year plus 20 percent of the actual investment result. Sometimes they ask for more.
Institutions will use their financial clout to strong-arm fund managers into charging lower prices, but private investors may well choose to return to equity markets instead, where returns may be similar and fees are much lower.