Dominance of Hedge Funds on Display in Third Quarter

The recent chaos in the credit markets and attempts on Capitol Hill to raise taxes have failed to put a damper on the lucrative hedge fund industry.In fact, investors have allocated a record-breaking $164 billion so far this year to the industry, according to Chicago-based Hedge Fund Research. This far surpasses the $126 billion invested during all of last year, which was also a record.This is good news for New York City, where 44 of the top 100 hedge funds are located, and where 32% of the world’s hedge fund assets, or $436 billion, are based.“The fact that hedge funds are doing well is very good news for the New York City economy,” the president of the Partnership for New York City, Kathryn Wylde, said. “It is a key industry for the city’s commercial real estate market, with hedge funds paying some of the city’s highest rents, and it also has a multiplier effect, creating four to five additional jobs for every highly paid hedge-fund employee.”This summer, a crisis that started with defaults in the sub-prime mortgage market spread across sectors, sending equity and bond prices plummeting. The Standard & Poor’s 500 Index lost more than 6% from early July through mid-August. Some hedge funds closed their doors, including two run by Bear Stearns, and others, like those run by Goldman Sachs Group, posted large losses.Despite some blowups, however, many hedge funds swelled with new capital. The reasons include the flexibility that hedge funds offer during a volatile market, and the fact that many institutional investors withdrew their allocations from the private equity industry — which was one of the hardest hit by the credit crunch — and hedge funds were an attractive alternative.“If you remove those in-house hedge funds run by the investment banks, hedge funds in general performed well during the summer,” the president of Aurelian Management, Brian Horey, said.In the third quarter, hedge fund assets jumped $45.2 billion, bringing total industry assets at $1.81 trillion, according to Hedge Fund Research, which generates its data from more than 11,000 hedge funds.“I think investors are focusing on the longer-term merit of the industry, rather than month-to-month variations,” president of Hedge Fund Research, Kenneth Heinz, said.The average hedge fund returned 1.36% in the third quarter, a moderate increase for a period that included an average decline of 1.48% in August and a gain of 2.82% in September.The returns are in keeping with those reported by the research firm Morningstar. Morningstar, which bases its data on 7,500 hedge funds, found the industry posted an average third-quarter return of 2.44%, outperforming the S&P 500 Index. The positive third quarter results were helped by a 3.7% average gain in September.“September was the best month in a long time,” a hedge fund analyst at Morningstar, Nadia Van Dalen, said. “Everybody was scared in August, but it was an overreaction, and September more than compensated for that.”Nearly half of the new money invested into hedge funds, or $22.5 billion, went to so-called funds of funds, where investors can invest in a fund that has positions in several different hedge funds. The reason these funds of funds were so attractive was because they allow investors to diversify their exposures, and also provide access to some of the top fund managers that are otherwise not open to new capital, Mr. Heinz said.In the third quarter, the worst performing strategy was high-yield fixed-income, or high-risk debt, which also experienced the biggest percentage jump in new assets, attracting $2.2 billion, compared with $178 million during the second quarter. The reason investors flocked to high-yield fixed-income funds is because yields on these investments rose as their prices dropped, so investors felt they were more fairly compensated for their risk, Mr. Heinz said.“There remains huge institutional interest in hedge funds from pension funds, insurance companies, and the like,” a principal at the hedge fund Magnum Funds and president of the Hedge Fund Association, David Friedland, said. Despite investor demand, “it is surprising it is a record quarter, given that generally when there are large macro events like the one that occurred over the summer, it tends to scare investors away,” he said.

Dominance of Hedge Funds on Display in Third Quarter

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