January 19, 2007 / 11:31 PM / 13 years ago

Hedge funds less profitable for newcomers

BOSTON (Reuters) - Once considered a sure bet for outsized returns, the hedge fund industry may be losing some of its edge now that more investors want in and hundreds of new funds are ready to take their money, portfolio managers said.

“I believe it is going to become more of a bipolar world,” with some funds being very successful and able to deliver excellent returns and other who will not, said Mohamed El-Erian, who manages Harvard University’s $28 billion endowment and allocates to several hedge funds.

While the $1.2 trillion hedge fund industry beat the broader market with average return of 9 percent last year, the double-digit gains of the 1990s may be gone forever as the industry becomes more crowded which makes it harder to find outstanding investment choices, experts said.

Hedge fund industry assets have doubled in the last five years and the number of funds has ballooned to at least 8,500.

“With this kind of proliferation of funds, all guys can’t be great,” author, educator and hedge fund manager Joel Greenblatt said, adding “the good will thrive but most won’t.”

The managers spoke at the Reuters Hedge Funds and Private Equity Summit in New York this week.

This may be especially bitter news for traditionally conservative investors like pension funds which are now turning to hedge funds to try to boost returns quickly as many struggle to meet payment obligations.

A recently released study, prepared by State Street Corp., found that more pension funds and endowments are getting comfortable with these lightly regulated investment vehicles and are planning to sign up more managers in the months ahead.

Hedge funds, unlike most mutual funds, are able to use trading techniques like selling stocks short and borrowing money to make gains — or losses — add up quickly.

But as pension funds follow in the footsteps of the California Public Employees’ Retirement System, or CalPERS, the biggest U.S. pension fund which invests roughly $2.5 billion of its $207 billion in hedge funds, many are finding they aren’t welcome at some of the industry’s most promising funds.

For example, Boston-based hedge fund Convexity Capital, which raised $6 billion to become the largest hedge fund ever launched, will not take pension fund money, some disappointed would-be investors said.

Many hedge funds don’t want pension fund money because they would have to give more explanations to their investors about how they manage money and likely have to register with the Securities and Exchange Commission.

Private investors and endowments like Harvard and the University of Colorado Foundation, all ready to leave their millions with Jack Meyer for several years, were luckier to get in.

“It is true the very large hedge funds often don’t want to get involved with pension funds,” Mark Rosenberg, chairman and chief executive of the $1 billion SSARIS Advisors LLC hedge fund firm said, adding however that many less known funds are eager to court institutional money because it tends to stick around longer.

But that forces pension funds to look for winners in the quickly growing pool of new managers with the help of consultants or funds of funds which often charge high fees.

Pension funds are probably not well equipped to pick top managers before they become successful, Greenblatt said, adding “It probably won’t be an incredibly fruitful world for them.”

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