Post-Madoff HF Investors: Some stop, some go, and some start their own funds

It’s fair to say that the Madoff situation has added insult to injury for the hedge fund industry and may have prompted some hedge fund investors to finally capitulate.  The New York Post recently wrote:

“Now the worry is that hedge-fund clients will use the scandal as a final reason to pull money from even solid-performing managers. Although Madoff technically did not run a hedge fund, the structure of his $17 billion asset-management operation was similar to some hedge players.

“What’s more, Madoff’s ties with hedge fund of fund mangers, who placed their clients’ money in his advisory business without doing the kind of due diligence that might have uncovered the alleged scheme, has further eroded confidence.”

But wait…

But with many Madoff assets coming from private banks, there may be a schism developing within the ranks of institutional hedge fund investors.  Public pension plans may not be running for the hills, says the WSJ:

“Hedge funds have suffered through their worst year in more than a decade, punctuated by the Bernard Madoff scandal. But some public pension funds aren’t writing them off, at least not yet.

“Chief investment officers for pension funds note that despite some worrisome drawbacks, hedge funds continue to outperform stocks, and by a good margin. Hedge funds are down less than 18% this year, while the Standard & Poor’s 500 index has dropped close to 41%.”

Buy vs. Build

Pensions & Investments recently found that European pensions remain solidly focused on absolute return strategies despite the Madoff saga.  In fact, P&I reports that several European mega-pensions are actually launching their own internal hedge fund operations to overcome the types of transparency issues raised by the Madoff fiasco:

“Driven by inadequate transparency, performance problems and redemption issues among external hedge fund managers, pension fund officials at the 367 Danish kroner ($69 billion) ATP pension plan and the €23 billion ($32 billion) Ilmarinen Mutual Pension Insurance Co. – a multiemployer [FInnish] pension fund  – are quickly building their own hedge fund expertise.

“Also, Hermes Investment Management Ltd., London, which manages the £34 billion ($52 billion) BT Pension Fund, is also preparing to launch its own hedge fund team as soon as early next year. As a result, billions of dollars in absolute-return strategies from these three funds might be shifting in-house.”

These investors have opted to keep the baby (alpha-centric investment strategies) while throwing out what they see as the dirty bathwater (an opaque and illiquid hedge fund business model).

“Dislocations” too juicy to resist

Over the past couple of months, a growing chorus of hedge fund has been suggesting that recent market dislocations are good news for alpha-centric strategies in the medium and long-term.  And this may not just be empty marketing.  According to P&I, institutional investors are sensing the same opportunities.  Thomas Gunnarsson, the co-chief investment officer for alpha at Danish plan ATP tells the newspaper:

“There are tremendous dislocations in the industry, among them in the credit and convertible (bond) space. Going forward, there is going to be a lot of opportunities … We’re trying to develop in-house expertise to place us in a better position to take advantage of those opportunities.”

Pensions competing with traditional hedge funds?  Just another example of why it’s not about hedge funds, mutual funds, or pension funds, it’s all about alpha.

Hedge fund outflows vs. mutual fund outflows

In a related story, FT reported this week that November hedge fund asset outflows topped out at $32 billion according to Trimtabs.  When you add this to HFR’s Jan-Oct net redemption figure of $43 billion, you get $75 billion or about 3.75% of YE ’07 AUM.

Also this week, the Investment Company Institute (ICI) reported mutual fund asset flows for November –  providing some interesting perspective on these numbers.  While assets in US mutual funds were down by $261 billion in November, only $41 billion of that was from net redemptions.  The rest was from negative returns.  For the year to November 30, investors pulled $197 billion out of US mutual funds or about 1.6% of YE ’07 AUM.  For stock funds, Jan-Nov redemptions were about 3.3% of YE ’07 AUM.

That’s not too far from the hedge fund figures above, suggesting that hedge fund redemptions – at least so far – are comparable to US stock mutual redemptions.  But before the hedge fund industry breathes a sigh of relief, it should check out Trimtabs’ December hedge fund redemption forecast (cited by the FT): $80 billion.

If the New York Post is right about the Madoff scandal providing a reason to pull money out of hedge funds, that number could be at the low end of the range.  After all, it appears that well over $20 billion could have been instantaneously sucked out of the industry on December 11.

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