Hedge funds brace for pain

Published: Tuesday, January 13, 2009 at 6:01 a.m.
Last Modified: Monday, January 12, 2009 at 7:14 p.m.

NEW YORK - Year after year, the hedge fund industry dazzled Wall Street by delivering "absolute returns" - outsized profits whether markets rose or fell. Using sophisticated trading models, the pools of managed capital made wealthy people wealthier with eye-popping returns that carried seemingly moderate risk.

Not these days. Blind-sided by a colossal market collapse and the widening Bernard Madoff scandal, hedge funds suffered their worst showing on record last year. And they're bracing for more pain in 2009. The industry's fall proves that even the quantitative brilliance and market wizardry of elite hedge funds are no magic bullet for investors during brutal times.

"Hedge fund managers have always said, 'Look, we know how to make money even in difficult times,' and that turns out to be a fallacy," said Timothy Brog, portfolio manager of New York-based hedge fund Locksmith Capital Management.

Nearly 700 funds - 7 percent of the industry - shut down in the first three quarters of 2008, up over 70 percent from the same period the previous year, according to Hedge Fund Research, a Chicago-based data firm. At that rate, roughly one in 10 hedge funds will have disappeared last year when final numbers are released in coming weeks.

Thousands more are expected to die in 2009 as investors who have been clobbered by losses yank out what's left of their money. Those investor redemptions have forced many hedge funds to liquidate large chunks of their assets, triggering "dramatic" swings in the stock market late last year, Brog said.

"Even if hedge funds make up only 10 percent of the market, it's going to have a big effect if they sell all at once," he said.

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