Despite blue-chip gains, hedge funds are faltering and closing

As Jim Sinclair was saying....

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Despite Blue-Chip Gains, Hedge Funds
Increasingly Are Faltering and Closing

By Anita Raghavan,
Ianthe Jeanne Dugan,
and Gregory Zuckerman
The Wall Street Journal
Wednesday, October 4, 2006

As the Dow Jones Industrial Average climbs to record heights, many hedge funds are stumbling and more than ever are closing shop.

The latest to falter: Vega Asset Management. One of the world's largest hedge funds a few years ago, Vega has suffered losses from a bad bet against U.S. bonds, and is now down roughly 75% from its peak two years ago to about $3 billion in assets. The firm says it has no plans to cease operations.

New figures show that more than 1,000 hedge funds have shut in the past two years, as competition has squeezed profits. Even some veteran managers, in a bid to boost returns, have made concentrated bets that have backfired. All this has set up the $1.23 trillion industry for its first meaningful consolidation, Wall Street executives say.

In just the past few weeks, Amaranth Advisors LLC announced plans sell to its investments after losing $6 billion, mostly in the energy markets, heightening the prospects it will close its doors. Narragansett Management LP in New York recently said it will return $800 million to investors. And two European-based hedge funds recently have told investors they are shutting down one or all of their funds.

Vega, which has offices in Spain, London and New York, managed about $12 billion a couple of years back and about $6 billion as recently as January. It once was seen as a winner in the growing popularity of hedge funds among large institutions.

But Vega has suffered a series of losses in various markets in the past few years. Most recently, Vega placed a big wager that the price of U.S., European and Japanese bonds would fall, a Vega executive says. Instead, the bond market has rallied sharply in recent weeks, amid signs of slowing global economic growth, leading to losses as bond prices rose. Vega's largest fund, Vega Select Opportunities fund, which manages about $1.4 billion and is run by star trader Ravinder Mehra, lost about 11.5% of its value in September -- much of it coming in the last week of the month -- and is down about 17.5% so far this year.

"We're obviously not pleased about the deep losses but to make money you have to take risk," says Benjamin Mann, a marketing executive at Vega.

Vega's misstep comes as a number of hedge funds -- investment pools catering to wealthy individuals and institutions -- have closed their doors for business. The shutdowns are noteworthy because they include a couple of funds run by managers with sterling pedigrees. Among them: two funds set up by Hans van Hoof, the former Europe chief of Soros Fund Management and another fund run by Thierry Serero, a former manager at Fidelity Investments' Fidelity Europe mutual fund.

"The number of hedge funds will go down as there is consolidation among players in the industry and some funds go out of business," predicts Jamie Dimon, chief executive of J.P. Morgan Chase & Co., which bought a majority stake in hedge fund Highbridge Capital Management in 2004.

The fund closures, which stem from a variety of reasons, underscore a numbing fact about the hedge-fund business: Even though new hedge funds seem to be popping up every day, almost half as many funds have been closing their doors since 2005.

Since January 2005, a total of 2,622 new hedge funds have been launched, according to Chicago-based Hedge Fund Research Inc., which compiles data on the industry. But 1,071 funds closed during that time. In 2005 alone, 848 funds closed, representing 11.4% of the funds in operation at the start of that year. This is more than double the closure rate of 2004, when 296 funds shut, or 4.7% of the funds in business at the start of that year.

The proliferation of hedge funds in recent years -- the number of funds has doubled in the past five years -- has meant more funds chasing fewer ideas, squeezing returns and triggering big market swings. Hedge funds have returned an average of 6.9% this year through the end of August, according to Hedge Fund Research's composite index. That compares with full-year returns ranging from 31.2% in 1999 to minus 1.45% in 2002. In 2004 and 2005, Hedge Fund Research's composite index returned slightly over 9% each year.

What's more, the hedge-fund world increasingly is becoming bifurcated, with hot funds run by managers like Eric Mindich's attracting the buzz -- and the bucks from investors. About 300 hedge funds manage more than $1 billion each and represent roughly 90% of the assets in the industry today. "In the older days, raising $100 million was great," says Richard Portogallo, head of U.S. stocks at Morgan Stanley. "Now it is not going to be good enough."

Some burned investors have become skeptical of hedge funds. "I am skittish to say the least," says Dan McAllister, San Diego County treasurer who sits on the board of the $7.7 billion San Diego County Employees Retirement Association, which had about $175 million invested in Amaranth. Amaranth declined to comment.

Despite an annualized 16.9% return since inception, the "performance these past two years has been below my standards," says Narragansett's managing partner Joseph L. Dowling III. So far this year, Narragansett I LP is down 2% as of Aug. 31.

Mr. van Hoof, citing his experience at Bankers Trust and with billionaire hedge-fund manager George Soros, says he is "used to 15% to 20% years." Despite a strong start in 2003, which boosted assets to $850 million in 2004 from $20 million, his funds' performance faltered lately. Last year and so far this year, Mr. van Hoof's funds were up slightly over 3%, he says. "I am 90% sure I will be back but I need some time out to think about why we didn't do as well as we should have," Mr. van Hoof says.

Mr. Serero's C60 Capital was one of the funds that was forced to contend with the challenges of being small. Despite strong returns, the fund remained below the $50 million mark for most of its short life. "We had a bit of chicken and egg problem," says Mr. Serero about his decision to return money to investors. "We were too small to get the big investors."

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