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.

Yesterday we told you about a 2006 study of the SEC’s “Form ADV”.  Academics questioned whether the form - a centerpiece of the SEC’s plan to regulate hedge funds that year - was “redundant” since the due diligence performed by many hedge fund investors reveals the same information anyway.

Today, we continue on the theme of hedge fund due diligence with a look at another study co-authored by two of the same authors.  In “Hedge Fund Due Diligence: A Source of Alpha in Hedge Fund Portfolio Strategy“, Stephen Brown, Thomas Fraser and Bing Liang examine the value of the due diligence performed by funds of funds.  This is a particularly relevant issue right now as funds of funds come under criticism for not being able to forecast the Madoff saga.

Brown, Fraser and Liang cite a previous study that most hedge fund liquidations involved an operational component and over half of hedge fund liquidations prior to 2003 were the result of “operational issues alone”.  In fact, that study (by Feffer & Kundro) found that:

• 41% of liquidations involved “misrepresentation of investments and performance”,
• 30% involved “misappropriation of funds and general fraud”,
• 14% involved “unauthorized trading and style breaches,and,
• 15% involved “inadequate resources” or “other operational failures”

Brown, Fraser and Liang estimate that the average fund of funds due diligence effort costs US$50,000 to US$100,000 per underlying fund.  Like any fund cost, it represents a net against alpha.  Expenses and management fees, after all, are uncorrelated to returns and therefore are pure (and negative) alpha.

Therefore, as fees fall, alpha rises.  Since due diligence costs are essentially fixed, the larger the fund of funds, the lower the fee per dollar of assets.  So more AUM in a fund of funds necessarily leads to greater alpha, ceteris paribus.

Great theory.  But does the empirical evidence support this hypothesis?  Yes, according to the authors:

“Alphas of large funds of funds are significantly higher than those of small funds of funds, evidence of significant economies of scale…”

“Funds of funds large enough to absorb the high cost of due diligence have in principal a significant competitive advantage over smaller funds of funds.”

By comparison, there appear to be dis-economies of scale for single-manager hedge funds.  The authors divided single-manager funds into AUM quintiles and compare their performance.  It turned out that the largest single-manager funds (quintile #5) actually had the lowest returns.

The study also made another interesting observation.  It found that larger funds were more likely to use more “well known” service providers (auditors, administrators, counsel etc.).  While this makes intuitive sense, the authors propose it as evidence that small funds (single-manager and FOFs) “lack the necessary funding to compete effectively with their larger brethren”.

Despite concentration in the accounting industry, the study found that only 26.8% of single-manager funds and 30.9% of funds of funds actually used “well known” auditors (i.e. those who were used by more than one other fund ).  Less than half of the largest funds of funds used well known auditors and only a third of the largest single manager funds used them.

So smaller funds of funds face a double-whammy.  They sacrifice alpha in the form of higher due diligence costs and they lack the marketing benefits of well known service providers.

Academic research on hedge funds can be tremendously valuable to investors. But with increasing complexity, comes a greater chance that research conclusions can be interpreted in many different unintended ways.  For example, a widely publicized study released last week by Andrew Ang and Nicolas Bollen was presented by some as evidence that gating provisions themselves have a certain calculable cost.

As Reuters reported:

“In a paper titled “Locked Up by a Lockup: Valuing Liquidity as a Real Option,” Mr. Bollen and Columbia Business School’s Andrew Ang show that a manager’s right to block redemption requests “generates an implied cost of between 5% and 15% of the initial investment.”

This claim was likely based on the following statement in the introduction to the paper:

“…we show that a manager’s discretion to block redemption requests using gate restrictions or suspension clauses generates an implied cost of between 5% and 15% of the initial investment.”

Gate Provisions vs Gate Closures

Like Reuters, we read this to mean that the manager’s right (option) to cease redemptions was worth the equivalent of 5-15% of the value of the fund.  But a more detailed reading of the paper left us with the understanding that the manager’s actual decision to halt redemptions - not simply their option to do so - had the effect of immediately decreasing the value of the fund by 5-15%.

Ang and Bollen put a price on the investor’s option to redeem at their freedom.  The following table shows the value of a fund with a given volatility, a given likelihood of failure, and various expected mean returns (6%-14% per annum) under 5 separate liquidity regimes (columns from left to right: no liquidity, 2 yr lock-up + 3 month notice,  2 yr lock-up only, 3 month notice only, no restrictions at all).  The numbers represent the fair value (in dollars) for a fund with a $100 NAV on the day of its launch (i.e. at “Age=0″).

As the authors explain:

“Panel A shows that for relatively low expected returns, such as 8%, the potential cost of redemption suspension can be enormous, with $85.37 [for the no-liquidity scenario] $100.26 [for the 2 yr lock-up, + 3 month notice scenario]. This implies that the investor is receiving an asset worth about 15% less than NAV [when gates are closed], rather than one worth about par when the liquidity option is honored.”   [our notation]

So it would appear that a newly-gated (or always-been-gated) fund should suffer a 15% decrease in expected value vs. a fully-liquid one.  But this does not necessarily mean that a fund with a mere gating provision should be discounted by this amount.

We called Bollen to confirm this and he explained that in situations where investor redemptions coincide 100% with the imposition of gates, then an initial investment in a fully-liquid fund is, for all intensta nd purposes, locked-up.  In other words, liquidity is only there when you don’t need it - and disappears when you do need it.

Of course, hedge fund investors redeem for all types of idiosyncratic reasons.  So the value of the possibility of a gate being imposed falls somewhere between the extremes of a 100% liquid fund and 100% illiquid fund.

Recovery Rate

Still, an instant drop in expected value of a fund once a gate has been closed is still a tough nut for investors to swallow.  This immediate discount is based on a number of assumptions regarding the fund’s volatility, mean return, the likelihood of the fund liquidating given its strategy and age, and the expected recovery rate in the event of such a liquidation.

As Ang & Bollen explain, their analysis assumes that if a gated fund liquidates, investors will receive only 50% of their money back:

“Upon failure, we assume as a base case that investors receive a payoff of 50% of the prevailing NAV of the fund, reflecting additional loss of asset value during liquidation. The 50% liquidation cost is based on results reported in Ramadorai (2008), who analyzes a sample of transactions on a secondary market for hedge fund investments conducted on Hedgebay.  During 66 “disaster” transactions, involving fraud or collapse, the average discount of transaction price to NAV is 49.6%.”

Dead Funds

But the final discount to NAV is only a proxy for the actual recovery rate for a liquidated hedge fund.  Regular readers may remember Ramadorai’s paper from this AllAboutAlpha.com post.  In his paper, Tarun Ramadorai of the University of Oxford finds that investors trying to redeem out of funds that eventually end in “disaster” do so at a 49.63% discount to last reported NAV (note: “disaster funds” are define as “funds that suffered heavy and publicly reported losses and are either liquidated, or likely candidates for liquidation, or have been implicated in the press for fraud.”)

But other researchers say that the actual amount recovered when funds liquidate may actually be far higher than 50% (i.e. the loss may be much lower).

In a paper published around the same time as Ang & Bollen’s, James Hodder, Jens Carsten Jackwerth, and Olga Kolokolova studied “dead” hedge funds (defined as those who stopped reporting to a database).  Hodder, Jackwerth and Kolokolova argue that common assumptions about “dead” funds may be overstated:

“…we find that the estimated average delisting return is fairly small and nowhere near values of -50%… [our research] provides rather strong evidence that on average, delisting returns are far from disaster scenarios with exit returns of -50% or worse.”

In fairness, Ramadorai’s 50% recovery rate is based on funds that suffered “heavy losses” prior to liquidation and Hodder, Jackwerth & Kolokolova base their findings on all funds that simply ceased reporting to a database.

But as Ang & Bollen show, the recovery rate still has a significant impact on the value of the investor’s option to liquidate at their freedom.  The following chart from the paper shows that the investor’s liquidity option on a fund with an 8% expected return has a significant value when recovery rate (”l“) is 50%, but no value at all when the recovery rate is, say, 81%.

So, the cost of the “no liquidity” (already-gated) regime in influenced by recovery rate assumptions.  But the recovery rate also impacts the cost of the plain vanilla “2 yr lock-up + 3 month notice” liquidity regime.   In the chart below from the paper, “restriction cost” refers to the cost of these standard liquidity restrictions (vs. the full liquidity regime).

Note that even if you assume a low 6% annual return and a 50% recovery rate in a potential liquidation, the value of the standard (2 yr lock-up + 3 month notice) liquidity restrictions is still less than 5% of the fund value.

This is a very interesting paper.  But as usual, we need to be careful when interpreting it.  The study is about the value of being able to redeem - not about the value of a manager’s option to cease redemptions.

Perhaps in an acknowledgment of the complexity of these issues, the authors draw only general lessons in their interview with Reuters:

“This paper was written for academics, but I think it has practical applications…The legalese that described the vague rights that managers have and that a lot of people may have skimmed over in the past could turn out to be very important.”

“Very important”, yes.  But contrary to media reports, the study does not actually value “the manager’s right to block redemption requests.”

For generations, those who have predicted the end of the world have relied on specific dates of religious or astronomical significance (e.g. the Mayans, whose doomsday calendar is pictured at right).  This isn’t lost on Hollywood, which began filming the apocalypse movie “2012″ in August.  (Thankfully, the movie will be released in ‘09, giving us a couple of years to prepare).

Last week, Dow Jones reported that one consulting firm predicted a coming hedge fund apocalypse with between $650 billion and $700 billion being “withdrawn from hedge funds” this year.  A week before that, however, Citi said that it expected only $100 billion to be redeemed in Q4 and just this week Lipper TASS reported Q3 hedge fund outflows of only $18.6b or 1% of assets.   As we have reported here, estimates of hedge fund redemptions are all over the board.  The FT ran the following chart last week using HFR data, that shows the size of recent redemptions in relation to previous subscriptions:

In an effort to gauge hedge fund redemptions, many have been looking to specific dates with mystical properties.  For example, the media branded June 30, September 30 and November 15 as “D-Days” when a sudden flood of redemption requests would kick-start a round of selling by hedge funds.  It seems that “D-Days” tend to occur only after a negative performance for hedge funds.  Reuters also branded August 15, 2007 as a “D-Day”.

While we’re not sure exactly what they were expecting, it seems apparent that the hedge fund apocalypse didn’t actually occur on these particular days. The argument was that many hedge funds allow quarterly redemptions and have either 90 day or 45 day notice periods for withdrawals.

But there is very little empirical evidence that such arrangements dominate.  In fact, HFR says that half of the funds it tracks allow monthly redemptions and only 35% have quarterly redemptions.  To further muddy the waters, not all investors wait until the last possible date to make their withdrawals and most managers don’t immediately dump shares as soon as they learn of a net redemption.  After all, the very purpose of a notice period is to prevent this kind of forced selling.

To make the situation even less predictable, there seems to also be a common assumption that redemptions only create “forced selling” by hedge funds.  But by definition, hedge funds have both long and short positions.  So to maintain a consistent net exposure, hedge funds also need to unload shorts in a frenzy of “forced buying”.  Sure, most funds are net long, leading to net sales buy hedge funds, but the aggregate effect of these sales is considerably mitigated by short positions.

With redemption figures possibly lighter than some have reported, redemption dates less meaningful than many assume, and the net market effect of hedge fund redemptions smaller than often believed, why the obsession with hedge fund “D-Days”?

There is little disagreement among industry watchers that a shakeout is occurring.  But this culling will likely play out over several quarters and likely won’t be as traceable to specific dates as some have predicted.  Like the other “redemption days” before it, hedge fund redemption days will leave those looking for some kind of finality rather unsatisfied.

ADDENDUM (Dec. 8): P&I reports today on a Morgan Stanley claim that says “Year-end asset values could plunge up to 45% once withdrawals are made.” That’s a scary headline number since Morgan Stanley has its finger on the pulse of the industry via its prime brokerage.

But further down the page, P&I says “The final redemption window of the year closed on Nov. 30, and requests average between 20% and 25% of assets for the majority of hedge funds…”.

That’s a considerably smaller number.  Apparently the US number may be smaller still.  P&I quotes one consultant with a 20% overall December 31 redemption estimate who says “…the U.S. market place had approximately 40% less in withdrawals which is attributed to the large amount of assets institutional investors.” [40% x 20% = only 12% redemptions?]

The bellwether funds of funds segment will apparently face even smaller redemptions.  Continues P&I: “…funds of funds will on average see redemptions of between 5% and 10% by year-end, mostly because of client rebalancing and liquidity needs.”

The story concludes with a Morgan Stanley forecast that the hedge fund indusrry wil rebound to $1.6 trillion by the end of 2009 (up from the $1.1-$1.3 trillion range on Jan. 1).  That’s either an astronomical return or a total reversal of recent redemptoin trends - prompting the question (from us): Will 2008’s redemptions end up just a blip in the long term inflow/outflow data?

A few weeks ago we wondered if reports of the death of the “hedge fund model” were true or whether hedge funds had just been knocked unconscious for a while.  Apparently we weren’t the only ones curious about the hedge fund afterlife.  On Halloween, of all days, researchers in the US and Germany (re-)released a study on the average returns of “dead” hedge funds.

“Returns of dead funds?” you ask.  Yes indeed.  James Hodder, Jens Carsten Jackwerth and Olga Kolokolova have developed a methodology they say allows them to calculate the returns of hedge funds that have stopped reporting to hedge fund databases (often inaccurately referred to as “dead”.)

Based on media reports regarding the number of hedge funds in the world, you might think that any fund that ceases to voluntarily report their returns has simply “blown up“.  But the authors of this paper say that only a fifth of funds that stop reporting actually say that it’s because they were liquidating.  Five percent say they have simply closed to new investments and 76% don’t say why they have stopped reporting.

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UK-based hedge fund consulting firm Allenbridge HedgeInfo published a report this week that includes what is likely the most comprehensive list yet of “urban legends” regarding hedge funds.  Call it a myth-busting cheat-sheet if you will.

As Allenbridge CEO Christopher Miller (see related post) writes:

“The rationale for hedge funds is bruised but still valid.  The saying that hedge funds can produce profits whether the underlying market is up or down is still true, but we now know what can happen when externalities happen, like removal of ability to short, exercise leverage or mass redemptions.”

Think the correlation between hedge funds and the equity market is up this year?  Think again.  According to Allenbridge, the 1-year r-squared of most hedge fund strategies is actually slightly lower than the 5-year r-squared (see chart below from report).

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It is often said that there are approximately 12,000 hedge funds in the world today (or at least there were until recently).  But often overlooked is the fact that many of these funds are managed by the same hedge fund company.  When most people think about a hedge fund, they implicitly think about the management company itself, not the legal organization of the assets managed by it.  On this score, there are roughly 3,000-4,000 hedge fund companies (a.k.a. “families”) in the world.

According to a new paper by Nicole Boyson of Northeastern University, the proportion of hedge fund families with more than one fund has grown from less than a third in 1994 to over half by 2007.  In addition, the number of hedge fund companies managing 10 or more funds has grown from only 10 in 1994 to 228 by 2007.  The following chart was constructed from the data in Boyson’s paper:

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Recent estimates about the imminent shrinkage of the hedge fund industry have varied widely.  So we asked one expert to help us cut through the confusion.

The FT reports today that “US hedge funds suffer heavy withdrawals” with US hedge fund investors pulling about $43 billion of capital out of the industry.  Some of this, posits one expert cited by the paper, is a result of investors preemptively pulling money out in anticipation of a ‘run” on the fund and the subsequent closure of redemption gates (see previous post).  Another insider told the FT that the hedge fund industry would shrink by 50% over the “coming months” with half of the decrease (approx. $500 bn) coming from withdrawals and half coming from negative returns ($500 bn).

Fifty percent is the highest in a string of recent predictions about the size of the global hedge fund industry.  In the same FT piece, JP Morgan estimated that less than 10% of funds will bleed from the industry.  Robert Elliot of asset manager Bessemer Trust told Thomson News recently that the number of hedge fund would be cut in half by the end of next year.  Credit Suisse expects the industry to shrink by a 33% in the next two years (UBP concurs).  And the Tabb Group says the second half of 2008 will see a 15% reduction in the number of hedge funds.

Will the growth numbers vary widely, they all have a negative sign in front of them.  To get a better idea of the extent and potential effect of hedge fund redemptions, we contacted one of the keenest observers of the hedge fund industry, Nicola Ralston, former chair of the UK’s CFA Society, recent contributor to AllAboutAlpha.com and co-founder of PiRho Consulting.

AAA:  Will redemptions really be as bad as reported?

Ralston: There is no easy answer to this one.  Clearly many individual funds are suffering from very large redemptions and will have to close as a consequence.  One option for these funds is to split into two different funds, one of which is liquidated in as orderly fashion as possible while the other continues with some kind of lock-in and/or fee reduction.

More interesting is whether this will happen on a scale which shrinks the industry significantly in terms of both fund numbers and total assets.  We would stick our neck out and say that perhaps 15-20% of the assets are at risk, rather than the figures of 30-50% which have been discussed in some of the press.

Institutional funds which have taken a considered decision to allocate to funds of hedge funds are unlikely to sell out in a knee-jerk reaction, although there may be some reallocation of strategies and products. On the other hand, some individual and family investors are reacting badly to seeing absolute losses, and are trying to liquidate for cash.

Many of the funds which will go under will be long only or long-biased emerging market funds that arguably had no real business being in a ‘hedge fund’ wrapper in the first place. Other funds at particular risk are those with strategies which are highly dependent on leverage, such as those in the convertible arbitrage sector. We also need to remember that this whole process is likely to be very drawn out as, in extremis, funds will impose whatever gates and lock-ins they can, not just to hold on to assets, but to ensure that assets don’t have to be disposed of at fire-sale prices.

It’s also important to distinguish between individual hedge funds and funds of hedge funds (FOHFs). There are a slew of articles forecasting the demise of the fund of funds industry, highlighting the liquidity mismatches that are squeezing FoHFs which have offered much better liquidity terms than their underlying holdings.  There have also been several articles about the impact of their “double fee” in times of negative absolute returns.  Indeed, it seems there is a large element of the industry that would like the FoHF model to fail, though it’s not clear what would replace it.  Do all hedge fund investors have the time or expertise to undertake their own due diligence, for example?  And, although we have long warned against FoHFs which take a cavalier attitude to severe liquidity mismatches, we should remember that almost all pooled products - and indeed the banking system itself - depend on investors not wanting to take their money out at the same time.

It does seem likely, though, that much of the money which is redeemed from FoHFs will not find its way back into hedge funds in the short term, and that this will be one of the contributing factors to the shrinking of the underlying hedge fund market.  How much will the FoHF industry shrink?  Probably the same amount as the shrinkage of underlying hedge funds, i.e. perhaps 15-20% of the industry, over and above the impact of market movements.

It’s interesting to compare performance of FOHFs with that of multi-strategy funds, which some have touted as a cheaper alternative to FOHFs.  The net of fee performance for year to date (up to end September) for these categories is remarkably close, with the HFRI FoF Index down 11.0% and the multi-strategy index down 11.3%.  The greater dispersion of multi-strategy performance and the greater exposure to manager risk, however, suggests to us that the majority of FoHFs are holding their own vs the multi-strategy funds. (All figures here are net of all fees).

We have always been very cautious about the idea the Multi Strategy funds are a good alternative to a diversified Fund of Hedge Funds, and see nothing in the current crisis to cause us to change that view.

AAA: Could redemptions really be large enough to impact markets materially?

Ralston: You probably saw the front page headline in the Financial Times yesterday ‘Hedge funds driving stock collapse‘, showing figures from Goldman Sachs which demonstrate that stocks which are heavily owned by hedge funds have performed markedly worse than those which are under-owned by hedge funds. There are a number of issues here…

• One feature of markets is that many investors tend to employ similar models (e.g. mean reversion or short term momentum models) which predispose them to be holders of the same investments even though they make their decisions entirely separately. As it is the marginal buyer or seller that drives the price, it is certainly possible for the prices of specific stocks to be particularly exposed to redemptions (or fear of redemptions) in the hedge fund market.
• In absolute terms the total value of all hedge funds is well under 10% of the value of the global equity market, so it is unlikely that even very large redemptions could be the main factor driving markets as a whole down.
• Some commentators almost seem disappointed that hedge funds do not appear to have been the catalyst for market meltdown, and are only too happy to find reasons to make hedge funds a scapegoat.  We rarely find companies complaining when hedge fund interest results in buying pressure.

It is, however, interesting to note that while hedge funds have understandably come under pressure for failing (for the most part) to live up to the ‘absolute return’ tag, most commentators are relatively phlegmatic about equity performance despite global equities being down more than a quarter this year, on the grounds that equities are ‘supposed’ to be volatile.  Interestingly, despite the awful absolute performance of the hedge fund indices, hedge funds have just had one of their best quarters relative to equities.

It is also worth considering the knock on impact of poor underlying performance and the imposition of gates and lock-ins on banks which offered capital guaranteed structured products on FoHFs.  Potentially unable to realise cash from the underlying FoHF, the structuring bank is stuck with a very large economic exposure; this is likely to be a continuing issue for parts of the banking sector into 2009.

As the Wall Street Journal pointed out earlier this week, “It may be premature to write the epitaph for funds of hedge funds”.

Maybe so, but with predictions for redemptions running in the high teens for this fall, one would be excused for believing the hedge fund “bubble” has burst along with the many other bubbles inflated over the past few years.

Yet, WSJ sister publication, eFinancial news reports this week that: “Pensions Continue Push into Hedge Funds”.  This seems to back up what research firm Cerulli recently concluded - that institutions are continuing to move from long-only to alternative assets (see Monday’s post for clear evidence of this).

Dow Jones points to the UK’s University Superannuation Scheme (USS) as one example of the new and more grounded institutional view of hedge funds:

Michael Powell, head of alternative assets at the pension scheme, said: ‘The turbulence in the hedge fund industry has provided USS with a great opportunity as a new entrant. The fallout in the industry will also prove to be a great arbitrator of quality and skill among the huge number of hedge funds.’”

Meanwhile, Phil Irvine, co-founder of PiRho Investment Consulting along with AllAboutAlpha.com contributor Nicola Ralston told The WSJ there would be:

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The numbers are in and it appears that hedge funds lost about 5% last month (see sidebar of this web page for full listing of hedge fund indices).  Bad, but looking relatively good with every passing day on global equity markets.  Excluding the long-biased energy and emerging HFR sub-indices, the number is closer to -4%.

In a recent note to clients last week, research firm Oxford Analytica expressed surprise at the apparent resilience of the hedge fund industry:

“Whereas banking sector difficulties have provoked a host of policy responses…no hedge fund problem has yet necessitated a similar systemic response.  The apparent resilience of the sector is particularly striking given that recent estimates suggest that the 2 trillion dollar hedge fund industry accounts for approximately 30% of US equity and bond trades…”

A “Run” on Hedge Funds?

But at least one economist says this is just the calm before the redemption storm.  Nouriel Roubini wrote in the FT last week that:

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