Hedge Funds Still Thriving in Volatile Markets

April 3, 2003 (PLANSPONSOR.com) - Despite - or perhaps as a result of - volatile markets, the hedge fund industry expanded by 5% in 2002, according to a new survey.

A combination of manager performance and new capital inflows added another $592 billion to hedge funds last year, according to the 9th Annual Hennessee Hedge Fund Manager Survey by the Hennessee Hedge Fund Advisory Group.

Hennessee said that hedge funds outperformed the broader equity markets in 2002, as the Hennessee Hedge Fund Index declined -3.43% net of fees, bringing the annualized return since January 1987 to 15.28%, versus the S&P return of 11.07% over the same time period.

Hedge funds were able to avoid what were termed “serious losses” by taking defensive positions and holding high levels of cash, according to Hennessee.   In 2002, the average hedge fund net market exposure was +33%, the lowest in the survey’s history.   At the same time the use of margin in 2002 declined to its lowest level since the survey began in 1994, as the average long exposure decreased 6% to 77%.

The average hedge fund manager aims to manage $693 million in 2003, down from $893 million in 2002.   One in five hedge funds provide their investors access to the entire portfolio, up from 17% in 2002.

Capital Sources

Fund-of-funds were the second largest source of capital (27% of assets), trailing individuals/family offices, which contributed 42% ($249 billion).   However, there is clearly a shift underway.   For example, in 1994 individuals/family offices comprised 80% of total assets.   And while fund-of-funds were also the second fastest growing source of capital (28%), they barely trailed the 29% pace of individuals/family offices in the most recent Hennessee data.

Due to the increased number of institutions offering hedge fund products, 50% of hedge fund managers were Registered Investment Advisers in 2002, up from 42% in 1998.   However, 25% are still not registered with any governmental or self-regulating body (SEC, CFTC, NASD, NYSE, NFA, etc.), according to the report.

Tech Threats

Hedge funds rely on their internal IT team for middle and back office systems (40%) with prime brokers second at 25%.   However, fund administrators are a close third with 24%, as hedge funds look for a way to consolidate services and benefit from price competition. Hedge fund managers cited client reporting (21%) and risk management (21%) as their biggest challenges for which they would expect technology to provide a solution.

The 2003 survey respondents include 793 hedge fund management companies and over $137 billion in assets, equating to 23% of total assets in the hedge fund industry.   The median hedge fund size in this year’s survey was approximately $124 million.