Hedge Fund Update: Assets Soar As Trading Gets Turbulent

(MoneyWatch)  Hedge funds are back in vogue, but (or perhaps because) finding those windfall gains is becoming a much harder job than it was at the beginning of the year.

In October, net inflows to hedge funds totaled $10.2 billion, representing more than a five-fold increase over new investment levels six months ago. In the same month that they received record investment, however, hedge funds overall lost money: $2.4 billion, to be exact.


The numbers make for three interesting preliminary conclusions:

• The first conclusion is that very few hedge funds are riding short positions right now: in other words, there is relatively little actual hedging going on. Both the S&P 500 Index and the Dow Jones Industrial Index were flat to lower in October, after they fell sharply in the final days of the month. This type of trading activity would account for the big losses and simultaneous high inflows of funds. Indeed, with so much cheap money sloshing around right now, there are not many investors who are daring enough to want to forecast the bursting of the current Fed-fuelled asset bubble.
• The second conclusion is that, now asset prices have risen so dramatically, individual high net worth investors are trusting a bigger portion of their capital to hedge fund managers, rather than choosing to make their own investment management decisions. Hong Kong-based Triple A Partners' executive Frank Packard told Bloomberg this week: "Hedge fund investors tend to be more long-term than month-to-month and we may be seeing some people taking money out of the equities market to invest in hedge funds."
• The second conclusion is that there are many more actors around now than there were at the beginning of the year. In May, I pointed out that a number of former bankers and mega-fund asset managers were going it alone and beginning their own, slimmed-down boutique hedge funds. In terms of racking up performance gains, these funds could not have opened their doors at a more opportune time. In effect, all they had to do this year was remain long energy and equities, and they will all be showing very pretty performance charts. It will be interesting to see whether any of these newer funds make names for themselves in specialized trading areas next year.

Many fund managers have grudgingly gravitated towards fuelling the financial sector's overall rise in 2009, which in turn has led to banks fuelling hedge funds' capital reserves through expanded prime broker services, capital raising facilities and even to starting branded funds themselves (think Nomura's (NMR) Lehman Brothers franchise in Hong Kong).

As a side note, even where speculation in financial stocks is taking place by hedge funds, there isn't a lot of consensus. For example, two of the world's largest hedge fund managers have almost opposing stances on Bank of America (BAC) right now. In the last quarter, SAC Capital Advisors said recently that it sold 7 million shares, or 90 percent of its stake in the bank. Meanwhile, John Paulson, chief executive of multi-billion dollar money manager Paulson & Co., wrote to investors last month that Bank of America will double in value by 2011 as writedowns ease. He counts Bank of America as his largest U.S. equity position. Paulson made around $20 billion speculating against mortgage-backed securities in 2007 and 2008.