Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Flows and Performance

The FoF sector has experienced a dramatic slowdown in growth since its peak in 2007. In fact, unlike hedge funds more broadly, the industry has contracted 15 percent since its peak and has had four negative growth years in a row.

According to data compiled by HFR, the strategy had steady growth from 2001 to 2007, increasing from under $510 billion to almost $800 billion. The product was one of the most adversely affected by the financial crisis. Assets lost in 2008 and 2009 exceeded $250 billion as a result of both redemptions and losses. According to the data in Fig. 8.2, the strategy also performed poorly during and after the crisis FoFs lost money in three of four quarters in 2008 and in the second, third, and fourth of 2011. The sector has continued to shrink in both its assets under management and its percentage of industry total assets, as many investors have moved away from the product in favor of direct allocations to managers or use of multistrategy funds. The number of firms offering the fund of hedge fund products has also contracted significantly as the industry has started to consolidate.

Figure 8.2 FoF Quarterly Performance, 1998 to 2011

Source: HFR Industry Reports © HFR, Inc. 2012, www.hedgefundresearch.com.

Investors have generally been rewarded with positive quarterly performance over changes in the business cycle. The strategy lost money ...