There have been a number of documentaries and op-ed pieces kicking over the ashes of the fire that burned Lehman Brothers into history. We know by now that hedge funds were not responsible for the market carnage that resulted, and, if anything, hedge funds as a group were victims of the demise. But what have been the later and second order effects of the collective loss of confidence of investors in hedge funds? A year on is enough time to see some of them.

In last month’s issue, we looked at how supply and demand for hedge funds played out through the year, and how the terms of business set between buyer and provider have changed, particularly for single manager hedge funds. We now look a level down from industry level impacts to effects on individual strategies. The focus thereafter is on funds of hedge funds.

Strategy returns
Last year the Credit Suisse/Tremont Hedge Fund Index, a good proxy for single manager performance, was down 19%. This year single manager hedge funds are up around 13%. It is very striking looking down the second and third columns of Table 1; as bad as last year was for returns at the strategy level, it is proportionately good this year. What was up is down and vice versa. Further, what was down most is now up most. So last year’s best investment strategies (commodity trading accounts, or CTAs, and short selling) are this year’s laggards, and 2008’s worst performers (emerging markets and convertible arbitrage) now lead the ranks. In fact this is also true at the level of the individual hedge fund. Individual funds which lost the most in 2008 have gained the most in 2009. According to work by TrimTabs the correlation of individual hedge fund returns in 2008 to returns in 2009 is –0.543 which is statistically significant, but also significant for investors in hedge funds. This reversal of fortunes at the strategy and fund levels has implications for funds of funds in particular, which shall be picked up later, but first a look at how the returns were produced this year.