Gluttons for punishment?

May 14th 2009 From The Economist print edition Investors in hedge funds remain unexpectedly enthusiastic HEDGE-FUND managers are not forgiving types but their customers appear to be. Six months ago the industry looked as if it could be crushed. Although hedge funds were not the financial weapons of mass destruction that many had feared, they spectacularly failed to achieve the absolute returns that were supposed to justify their high fees. Clients flocked to redeem money, which exposed the mismatch between the illiquid assets some mangers invested in and their volatile funding. To prevent fire-sales, some funds ended up locking in investors against their wishes. And then came the Madoff scandal, which confirmed the suspicion that some funds of funds, which are supposed to funnel money to talented managers, were only marginally less useless than Bernard Madoff’s auditor. That, in short, is the charge sheet against the industry. Yet a recent survey of most of the world’s big hedge-fund investors, by Goldman Sachs, suggests that clients remain surprisingly happy. Only 15% of their assets are subject to “gates” that stop them withdrawing money, suggesting there is little pent-up demand for further redemptions. Indeed, recent comments by several big managers indicate money is flowing back into their funds now. And, according to the survey, clients think funds of funds will continue to supply just over half of hedge-fund assets under management. Nor does there appear to be much appetite to reform the structure of hedge funds. One mooted solution to the liquidity mismatch is to give each client a separate “managed account”, rather than pooling them together in such a way that loyal investors are saddled with the most illiquid assets. Yet the survey suggests that few clients expect this idea to fly, at least this year. Are clients forgiving to the point of naivety? Perhaps. But the reality is that, a couple of blow-ups aside, hedge funds have proved less risky than most other financial firms. Their main weakness has been performance and here clients are being a bit tougher. An overwhelming majority expect fees to fall, for hedge funds and funds of funds. They are willing to stick with an industry with a mediocre record—so long as charges are lower. Slowly but surely, hedge funds are becoming like the old-fashioned asset managers they once aimed to usurp.