Institutional Money May Swamp Hedge Funds' Market

by Carla Johnson, Investors Offshore, London

14 May 2002

After many years in which hedge funds were the preserve of wealthy individuals, the last year has seen a major switch of institutional assets out of equities and other traditional asset classes into alternative investment sectors, meaning mostly hedge funds.

This movement is easy enough to understand: the pension funds and other institutional fund managers have been suffering poor returns or even losses from their equity and money market holdings, while hedge funds have continued to make gains. And as the hedge fund sector has increased in size by lowering its minimum investment levels and developing products that can be marketed more widely, it has started to seem less risky to conservatively-managed institutional fund managers. It would be going too far to say that the hedge fund sector has become respectable, but at least it no longer appears to be a dangerous jungle.

However, some commentators speculate that the arrival of institutional money may remove the ability of hedge funds to out-perform. As the absolute size of the sector increases (now somewhere near US$1 trillion in total) and as hedge funds respond to institutional demands for transparency, it is daily becoming more difficult for hedge funds to find the contrary market plays in which they specialise.

Interviewed in the Financial Times, Alain de Coster of Credit Suisse Asset Management, with $3.3bn of assets invested in 121 different hedge funds, says he believes that returns could be hard hit by an influx of funds from institutional investors: "Being below the radar screens is crucial for hedge funds," he says. "The moment they become the market they will trade against each other and it becomes a zero-sum game."

Mr de Coster also downplays the current performance of most hedge funds: "Most people in the hedge fund industry have achieved capital protection in the past two years," he says. "What hasn't been achieved are great absolute returns." He has closed his own G7 fund to new entrants, saying that he can't promise them satisfactory returns.

He claims that many other 'multi-manager' funds represent bad value for investors, because their managers are compensated by asset management fees rather than on performance, as has been usual for single hedge funds. "In the last two years, funds of funds have made more money from asset management fees than performance fees," he told the newspaper. "If this continues, investors should question why they have money there."

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