Lasair's McCabe sees hedge fund space less packed

NEW YORK (Reuters) - The ranks of hedge funds, which expanded rapidly during the past decade, are about to get a lot less crowded as poor 2008 performance takes it toll, industry veteran Carrie McCabe said on Wednesday.

Last year's market freefall wreaked havoc on hedge funds. Hundreds of firms shut down, the average fund fell 18 percent and investors yanked out a record $155 billion. And on top of that, Bernie Madoff's massive Ponzi scheme exposed dozens of fund managers who failed to protect their clients.

These events will trigger sweeping changes to the industry, McCabe, chief executive of Lasair Capital, said at the Reuters Private Equity and Hedge Funds Summit.

"There will be more redemptions at the end of (this) month, though not like last year," said McCabe, whose career includes running major fund-of-fund businesses at Blackstone Group and FRM Americas. "There has been a huge uncrowding. The industry could be down to $1 trillion at the end of the year -- that's half its size."

The carnage will be greatest among the thousands of small funds, but even the big players will be squeezed. McCabe sees the ranks of $1 billion-plus funds shrinking to about 300 from 400 this year, part of a "great dismantling" of the business.

"It wasn't just Madoff. It was the performance of these institutions last year," she said.

On the other hand, the great shakeout presents a more favorable environment for those still in business.

Investment banks dealing with their own credit issues have largely abandoned proprietary trading in many markets, such as convertible bond arbitrage, said McCabe, who in her latest venture is building a fund that will invest in a select group of hedge funds that both own and short stocks.

The industry also is poised for new regulation, though McCabe played down the concerns some critics have raised.

"A lot of that is posturing," she said. "If you run a business to business standards, you don't do anything extra" to comply with the Securities and Exchange Commission.

Regardless of what the government wants, investors are going to be more demanding of their hedge fund managers, seeking more disclosure.

"Investors very much want to know what is underneath the hood," she said.

Pensions, endowments and other institutions -- which now comprise 80 percent of the money invested in hedge funds -- are also going to ensure that high water provisions and other terms align a manager with his partners.

Surprisingly, perhaps, fund managers are not always opposed, she said.

"There is more of a request for transparency and managers are being very cooperative," McCabe said.

(Reporting by Joseph A. Giannone; Editing by Gary Hill)