The Great Hedge Fund Unwind Is Gaining Speed

In the coming months, the number of hedge funds will plummet.

Pressured by the massive consolidation within the commercial banking industry and fallout from the global credit crunch, hedge fund industry consolidation --which began a few years ago -- is accelerating.

Presently, the hedge fund industry is worth up to $2 trillion, but experts contend that nearly 30 percent of the estimated 10,000 hedge funds will either merge or simply discontinue operations in the coming months.

As for most financial institutions, these are difficult days for hedge funds. The average fund, after losing nearly five percent in the first eight months of the year, was down an additional seven percent in September, according to Hedge Fund Research.
What's more, hedge fund administrators are suffering from a vicious one-two punch: More nervous investors are clamoring for their money back; and commercial banks are sitting on cash reserves refusing to lend funds, especially to risk-oriented hedge funds.

Who will participate in the coming hedge fund consolidation?

A few years ago, the conventional wisdom said large financial institutions would lead the charge by acquiring funds with over $100 million in assets under management. Those days appear over as commercial banks such as JP Morgan Chase and Bank of America cope with their own bank mergers and while the investment-banking business restructures dramatically.

In addition, the possibility of a hedge fund going public is highly unlikely in this volatile stock market era. As a result, look for the industry to eat its own as healthier hedge funds gobble up all or part of their competitors.

One hungry example: Chicago-based Citadel Investment Group, which is adding more traders and products to its roster. Still, Citadel isn't immune to market forces; its mainstay fund is off 17 percent for the year.
Moreover, the regulatory environment for the highly-secretive hedge fund industry promises to get much tougher. Along with passage of the recent $700 billion economic "recovery" plan come expectations that financial services will become more tightly regulated and transactions will be conducted more openly. That will hit hedge funds, which have lobbied hard to maintain a veil of secrecy over their transactions, especially hard.

With investors and regulators ganging up on their business, some hedge fund managers may want to get out of the business while the getting is still good -- a motivation that will assuredly speed up the industry's consolidation.