Closing Hedge Funds May Distort Indices

by Carla Johnson, Investors Offshore.com

06 October 2006

Hedge fund research indices usually show a healthy picture; but do they allow for closing funds? New figures from Chicago-based Hedge Fund Research show that 11% of all funds closed in 2005.

'Survivorship bias', as it is called in the trade, may mean that published research doesn't take account of losses in closed funds. Most of the research houses claim to allow for survivorship bias, but it can be very difficult to get figures for losses of closed funds: they hardly send out press releases about it!

Hedge Fund Research says that 2,622 new hedge funds have been launched since January, 2005, but in the same period, 1,071 funds closed. Twice as many funds closed in 2005 as in 2004. Hedge Fund Research's own composite index returned slightly over 9% in each of the two years, and is up 7% so far this year.

Recent weeks have seen bad news from a number of hedge funds. Apart from the high-profile US$6bn loss by Amaranth, which now seems likely to liquidate itself, a large fund run by Vega Asset Management Partners is said to have lost 25% of its value in the last two months. Vega managed a total of more than US$10bn in 2004, but reportedly now has less than US$6bn under management. Of course, that may be due to redemptions, not losses. Who knows?

Vega's recent losses are thought to have been incurred on short positions in sovereign bonds, and a bet that the Japanese yen would appreciate against the euro.

Investor sentiment favours larger fund managers, such as the highly successful Man Group, and many obersevers say that a period of consolidation is likely as smaller, weaker funds run for cover in the arms of their larger peers.

Much of the hedge fund industry's growth in the last few years has been due to greater interest from institutional investors; a slew of high-profile casualties and negative reports from research houses will not encourage them to continue to increase hedge fund weightings.

One problem the industry probably won't face, however, is additional regulation. Although the US House of Representatives is launching a study of hedge funds, US Securities and Exchange Commissioner Paul Atkins said while on a trip to Europe last week that no new regulations on hedge funds are needed.

Atkins said the SEC would continue its probe into whether Amaranth misled investors, but that rules to prevent a widespread systematic failure in the market had worked. "It looked like the system worked" with the broker "getting nervous about exposure and taking steps to ensure it did not grow," Atkins told reporters in Brussels.

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