By Walter Kurtz, Sober Look

As discussed last month, the hedge fund industry continues to experience outflows. Net withdrawals that started in December 2011 continued through the first quarter of this year.

Given the increase in risk aversion since March, redemptions are likely to have accelerated recently. In particular Global Macro hedge funds are once again among the funds group that is struggling.

Throughout the second half of 2011, Europe became the bane of macro funds’ existence, as managers got constantly whipsawed by the whims of Eurozone politicians and bureaucrats. Investing based on relative value became irrelevant. Market trends (in currencies, commodities, rates, equities, etc.) kept reversing direction (sometimes several times a month), often rendering fundamental economic analysis completely useless.

Fund flows ($MM) by strategy

These funds continue to struggle with the same issues today, unable to recover even a third of their 2011 losses (see chart below). It looks increasingly unlikely that they will recover full losses (“high watermark”) before the end of this year, which means most will not qualify to collect incentive fees in 2012. Even Brevan Howard’s flagship fund which beat most of its competitors by returning 12% in 2011 is down year to date. Given its strong track record, Brevan Howard is going to be just fine, but its Global Macro competitors are likely to see further investor redemptions.

Global Macro hedge funds performance (source: DJ/CS Hedge Funds Index, 1/1/2011 = 100)

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Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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  1. According to the Financial Times a lot of/the majority of hedgefunds are “”long only”” funds. Then those funds would have suffered losses in 2011.

    I also think investors are squeezed financially (e.g. mortgage related problems)and are/were simply forced to withdraw funds.
    We saw that with Hugh Hendry’s Eclectica Fund as well. The fund was up 50% in 2008 but investors were squeezed financially in other markets and that’s why Eclectica saw a net outflow of money in the 4th quarter of 2008.

  2. Just like in a credit expansion period financial leverage explodes creating all sort of temporal performance and profits, in a credit contraction period financial outflows are as violent.

    Remember that ultimately finance produces nothing but paper, financial industry in essence is a ‘derivative’ industry, just like the complex derivatives other sort of traditional financial contracts have underlying real production and construct a net of obligations & claims on top of each other.

    When the productive fabric of society ‘depresses’ and it’s unable to met these derivative obligations (through ‘growth’ machine) the financial paper economy collapses. This is a complex process where outflows come from one part of the industry to an other but ultimately go to the ‘sinking hole’ of obligations payment under deleverage process. So clients withdraw funds as they desperately seek to achieve some income and capital appreciation in an economy which can’t produce a net income and capital appreciation (because the lack of sufficient growth). And as in the real world there is a degradation of the economy and obligations can’t be met, they feed of their previous ‘paper wealth’, withdrawing funds, to try plug the hole of these maturing unmet obligations.

    Wealthy clients are no different in essence than the average person only they have a wider space to maneuver and more ‘credit’ to extend and pretend (they can met the obligations), but liquidity issues arise anyway as the situation deteriorates and the “flight to quality” (liquid) still is necessary.

    That’s why we have these cries from financial pundits for central bank intervention or ‘targeting a nominal GDP’. Note that they are asking for NOMINAL growth regardless of real growth, because nominally they can’t cover the obligations with liquid. So as long as the growth machine languish the net outflows (since 2008) will keep increasing. And this one of the reasons a new secular bull market in ‘risk on’ assets is not likely, and why the ‘quality’ assets are probably going to continue performing well for some time.

    In the West, deflation; in developing nations, inflation risks. Both are dangerous to real growth which ultimately feeds the financial vampirism of the real economy.