When Hedge Funds Lose Their Mojo

We're not quite there yet, but hedge fund managers may soon need to start giving away toasters -- or perhaps plasma TVs -- to woo new investors. Forcing the funds to eat a little humble pie now would benefit hedge fund investors in the long run.

NEW YORK, June 9 - We're not quite there yet, but hedge fund managers may soon need to start giving away toasters -- or perhaps plasma TVs -- to woo new investors. Forcing the funds to eat a little humble pie now would benefit hedge fund investors in the long run.

Most hedge funds are off to a decent start this year -- the average return to date is 9.43 percent, says Hedge Fund Research. Yet it's a particularly tough time for launching a new fund. In the first five months of 2009, just 40 new funds have begun reporting performance figures, BarclayHedge reports.

That's a pittance compared with the same time last year, when 240 new funds started trading.

And investors, who were badly burned last year, seem more interested in pulling money out of hedge funds. This year the pace of redemptions is down only slightly from the fourth-quarter of 2008 -- when investors pulled some $165 billion out of hedge funds.

Look for redemptions to continue well into the summer, as temporary "gates" that blocked investors from fleeing for the exits, start to get lifted at some big funds.

Sol Waksman, BarclayHedge's president, says it will probably take "some period of sustained positive performance" before investors are willing to commit money to new funds.

But it may take more than a few "up" months for the hedge fund industry to get its mojo back.

So-called funds of hedge funds, big pools of investor capital which direct money to an array of funds, are fast disappearing.

The incredible shrinkage of funds of funds, which once accounted for 43 percent of all the money raised by hedge funds, means fewer places for managers to turn to for raising money.

Banks, meanwhile, continue to clamp down on financing for hedge funds.

After the easy credit of the last decade -- when starting a hedge fund was nearly as easy as opening a lemonade stand -- a period of anemic growth should be welcome.

As managers go begging for money, investors will get a lot more leverage in negotiating deals on the managers' fees that had once been considered sacrosanct: the 2 percent asset management fee and the 20 percent cut of the profits.

Investors should also seek their freedom from capital lockup requirements. Forcing investors to lock up their money for anything longer than a quarter at a time only makes sense for strategies that take a while to generate results, such as a fund that invests in distressed assets or agitates for management shakeups.

Investors stand to gain if the great hedge fund debacle of 2008 leads to a lasting rollback in hedge fund fees and culture that has emboldened managers to do as they please.

By: Matthew Goldstein

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