Formerly, hedge fund took investors' money and took it for a wild ride, leveraging it to absurd degrees and sinking it into obscure financial instruments. For those who had smart and/or lucky managers, the bets paid off big. But losers far outnumbered winners, as the numbers indicate -- hedge fund returns plummeted 19% in 2008, and are only slowly starting to recover.
The solutions, to summarize the article, are as follows. Hedge funds are much more transparent about their activities. They have also made it easier for customers to pull their money out if they deem the risk in the fund to be too high. Finally, hedge funds are offering additional, safer products for investors to sink their money into.
Yet these changes seem to disappoint the Economist, which states the following:
The increased cost of meeting the demands of institutional investors and regulators is tilting the industry towards ever-bigger firms. Investors already favour the larger, older funds, which they perceive to be safer bets. Most of the new money allocated to hedge funds in the second quarter went to those with assets over $5 billion.The Economist seems to idealize the old days in the same way the we have mythologized the Old West. Yet the Old West was a mean, desolate, dangerous place, and the old world of hedge funds was only better in the sense that millions of dollars were lost instead of thousands of innocent lives.
The smallest hedge funds will struggle under these conditions. Some may seek to share back-office costs with larger funds in return for a cut of their profits. Others will liquidate or put themselves up for sale. The industry is already consolidating. On August 3rd, TPG-Axon, a New York fund, announced a merger with Montrica, a London outfit.
Whether this bulking-up will be good for the industry as a whole is unclear. The most glittering returns have often come from smaller, younger outfits, which are now being sidelined. Giant funds often struggle to find ways to produce outsize returns, because they are too big to move nimbly in and out of markets. Mr Druckenmiller said one reason he decided to close Duquesne was its burdensome size.
Sorry, Economist, but those free-wheeling days of yore weren't as exciting as you might like to think. Or, rather, they were exciting until all the big, risky bets caught up with everyone.