What are we to make of hedge fund attrition data?

A hedge fund industry report published last week by Credit Agricole Asset Management contained so much information that you could take any number of messages from it.  Headlines ranged from the positive (“Hedge funds hold nearly $2.2 trillion, report says“), to the benign (“New York Home To 25% Of $2T Hedge Fund Industry“) to the downright negative (“Long Live Hedge Funds? Not Quite“).

We’re starting to see a lot of talk about hedge fund attrition and longevity.  But unfortunately, this issue is more complex than it is often made out to be.  For example, one media outlet said:

“…only 2.45% have been around 15 years or longer, with another 15.25% between eight and 15 years…The report found that 10.29% were under a year old, with another 14.37% between one and two years old.  In total, 38.6% of all hedge funds were no more than 2 years old.”

Naturally, in a growth industry many suppliers will necessarily be young.  Nothing about eventual longevity can be concluded by this fact.

Earlier this month, the Wall Street Journal took a similarly negative position based on scant evidence of hedge fund attrition (“Hedge Fund Figures Suggest Worse to Come“).  Said the paper:

“Double-digit drops last year in the number of new European hedge funds created and the amount of capital they raised are signs of much worse to come for hedge-fund managers, according to investors.”

Apparently the number of European hedge fund launches last year was down 12% in 2007.  According to one expert quoted in the article:

“The tide of hedge funds shutting down has only just begun…There is a long lag between poor performance and money flowing out of the door.  Hedge-fund losses in August were not great, but November was worse and January was worse still.”

The article goes on to cite various monthly drawdowns by various hedge fund indices (losses of 1.5%, 4.3%, 2%, 2.5%)  But these returns that would be considered modest daily hiccups by long-only investors these days.

Despite the doom and gloom from some experts, the Journal article concludes that hedge funds remain as popular as ever, pointing out the obvious: that hedge funds with above average returns will attract capital from hedge funds with below average returns.

“Managers who managed to outperform the average in August, November and January are likely to do well from the fallout. Investors remain keen to place their capital in hedge funds.”

So far, it seems the “tide of hedge fund shutting down” hasn’t actually begun.  Investment News reports this week that globally the hedge fund attrition rate was actually going down, not up.

“Despite market turbulence, the overall rate of hedge fund attrition rate slowed to -5.95% in 2007 from -8.28% in 2006 and -11.40% in 2005.”

Overall, the number of hedge funds increased dramatically last year (net increase: approximately 600 funds).  For comparison, 2007 saw an 18% increase in the number of mutual fund closures and a similar drop in the number of new mutual funds launched, prompting Investment News to report “Glutted Fund Market Slimming Down“.

Experts seemed much more sanguine about the increase in mutual fund closures.  According to an expert cited by Investment News:

“The downdraft in 2007 could mean that the market filled out and met the demand…It was also a turbulent market in 2007, which didn’t help at all in terms of new funds.” [our emphasis]

HSBC’s global head of hedge funds told The Australian essentially the same thing on Friday

“If you lose 500 or 1000 it’s not really the end of the world because as the hedge fund universe has expanded one has to say there has been a dilution of the quality.”

…but the paper ran with the screaming headline “1000 hedge funds may sink in turmoil”.

Funny how the headline writers prefer the more colourful “1000 hedge funds may sink in turmoil”, “Long Live Hedge Funds? Not Quite.” and “Hedge Fund Figures Suggest Worse to Come” over something like “Hedge Funds Filled Out and Met the Demand“.

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