Catastrophe Schmatastrophe: Hedge Fund Demise Overblown

Nothing aggravates and annoys me quite as much as journalists, investors, or anyone else for that matter, taking a short term view of things and predicting catastrophe (oh, and the British of course). The world (outside of Britain that is) is a pretty elastic and adaptive place. Things happen for a reason, people adapt and self-correct, the world goes on.

According to the Wall Street journal, citing Chicago-based Hedge Fund Research Inc., returns for hedge funds fell -2.8% last month, the worst month in six years and are headed for big trouble with their rich investors. Here we go again. Last time hedge funds had a period of really tough returns was in the summer/fall of 1998, and this fishy financial commentator remembers a couple of the prominent headlines back then. Let me share two of my favorites:

Barron’s, October 12, 1998: A Lousy New Year: hedge Funds have to brace for huge redemptions, come December 31 … The U.S. hedge-fund industry may be about to face one of the most serious challenges in its nearly 50 years of existence. The industry’s current problem is highlighted by the disaster that befell Long-Term Capital Management, the Greenwich, Connecticut, hedge fund that had to be rescued by 14 financial institutions last month. But beyond that, the hedge-fund industry’s heavy losses on Russian bonds in August, combined with losses suffered on last week’s swings in the currency markets, have left hedge-fund investors deeply disappointed. That disappointment is likely to lead to substantial withdrawals late this year.

The Globe and Mail, October 14th, 1998: “Hedge Funds join Tulip bulbs as Faded Mania” … At the time, you may also remember that the stock market was still soaring as the dot-com craze was the real mania.

So, what happened next? The stock market raged on (for a little while longer). The assets in Hedge funds grew by a modest $300 billion in 1999 from their 1998 level of $3.3 trillion. But, today, assets under management in hedge funds are estimated to be $9.9 trillion. Yes. Trillion. It appears the mania hasn’t exactly faded. Why not?

Because, hedge funds are adaptive, and because people put too much weight on what they see and experience in the short-term. Between 2000 and 2003, very tough years for the stock markets, hedge funds grew by over $2.2 trillion as investors became wary of losing money in traditional stock investments.

With the S&P 500 down approximately 13% so far this year, after another 1% loss in July, there hasn’t been any real place to hide. Broad bond indices like the Lehman Aggregate are also down for the year-to-date period too. With this market environment, I have to think that hedge funds will continue to grow, flourish and bloom. One thing I know for certain: Time will tell.