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| John Paulson made $3.7 billion in 2007 by betting on the collapse of the US subprime market.
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Hedge funds which have become synonymous for high returns in recent years have begun to falter as the ongoing financial turmoil wreaks havoc on their business models. In Ireland, over 9,000 are employed in about 40 firms in hedge fund administration.
Hedge funds which seek to make profit from rises and falls in the markets, date from the late 1940's. A derivative, a more exotic financial instrument, that has also received a lot of attention in recent times, has a longer lineage according to Credit Suisse and Greek philosopher Aristotle mentions the use of a call option-like agreement with olive presses in his writings dating back to around 300 B.C. The Swiss bank says this suggests that option-like agreements were common in ancient Greece. Maybe, but as Shakespeare wrote in the Merchant of Venice: The devil can cite Scripture for his purpose!
Credit Suisse estimates that 30% of roughly 8,000 hedge funds over the next few years will close.
US investment bank Morgan Stanley's Chief Executive Officer John Mack said this week tumbling markets may drive some hedge funds out of business, prompting his firm to ``resize.''
Funds fell 5.4% in September and 10.1% for the year compared with the Standard & Poor's 500, which fell 20% over the same period. They held a record $184 billion of cash as of August, according to Merrill Lynch, about 10% of the funds' assets.
On Thursday, the Financial Times reported that an unprecedented $43 billion was withdrawn from US hedge funds in September.
High leverage has been crucial for super returns and a fund that borrows $5 for each $1 of equity can turn a 5% gain from a leveraged-loan investment into a 25% gain.
Some hedge-fund managers are under pressure to liquidate positions as banks request more collateral to back funds' borrowing.
The Wall Street Journal says that Citadel Investment Group has racked up annual returns of as much as 30% for its largest hedge funds in recent years, but last year, it held about $7 of investments for each $1 it held. That figure has come down to about $4 this year. The firm holds about one-third of its assets in cash and has expressed confidence that it is well hedged. Still, Citadel's largest fund is down about 32% through Oct. 10th.
The use of sophisticated software based on intricate mathematical models has reaped huge returns for the top funds. But with so many funds under pressure, the 2 to 5% annual management fee and 20% of the profit fee model is also under stress.
In 2006, the top 25 hedge fund earners raked in more than $14 billion in fees - equivalent to the GDP of Jordan or Uruguay.
In 2007, the top earning US hedge fund manager John Paulson earned a record $3.7 billion in 2007 to top Alpha Magazine's annual ranking of the 50 most highly paid hedge fund managers. The Paulson & Co. head overtook George Soros and James Simons, who ranked second and third, at $2.9 billion and $2.8 billion, respectively. The top 25 on the list earned an average $892 million, up from $532 million in 2006.
The FT says today that Highland, one of the largest investors in the debt of companies owned by private equity, said it was closing two funds with $1.5bn in net asset value. Letters sent to investors in the funds say they plan to sell 40% of their assets, mostly bank loans, in the next 12 months.
John Authers, Investment Editor of the FT comments :" Hedge fund indices, which are imperfect, suggest they did little more than keep track with US equities until the beginning of this decade. Then, Hedge Fund Research of Chicago shows hedge funds strongly outperforming.
Is it a coincidence that this was the time when the cost of leverage – available to hedge funds but not to conventional regulated retirement funds – went to historic lows, as the Federal Reserve fought to avert Japanese-style deflation?
Once rates returned to more normal levels, hedge funds returned to matching the S&P. Theywere ahead of stocks for the first half of this year. But then came the break in the oil market, on which many had relied. And then came the forcible removal of leverage."
Ireland and Hedge Funds
IDA Ireland said earlier this year that Ireland has grown into a globally recognised centre-of-excellence in hedge fund administration with over 40 companies servicing approximately 37% of the total global industry from Ireland. Over 9,000 people are employed in the funds administration sector in Ireland.
According to the Ireland Hedge Fund Services Report 2008, which was published last June, statistics published by the Irish Funds Industry Association, show that the aggregate assets of Irish registered collective investment schemes grew from €361.8bn in December 2003 to €806bn by December 2007. The number of non-Irish registered funds administered in Ireland grew from 1,654 in June 2003 to 2,752 in December 2007, while alternative investment funds administered in Ireland grew in terms of assets under administration from $199bn in March 2003 to an estimated $1.01trn by December last year.
The report says an estimated 15,000 are now working in Ireland across the large number of fund administration and custody/trustee services providers, specialist legal, audit, tax and listing firms, and consulting firms.
The shakeout in the US hedge funds and general funds industry will have an inevitable impact on employment in Ireland in coming years. It will not have a comparable public impact as the expected closure of the main manufacturing operation of Dell, Ireland;'s largest merchandise exporter, but nevertheless, the effects will be significant.
