Traders at the New York Stock Exchange
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Hedge funds typically charge investors 1% of their money each year, as well as a performance fee of 20% of the fund's annual gains. That can be a lot of money. For example, the average hedge fund rose nearly 12% last year. That means someone who invested $1 million — often the minimum — in an average hedge fund last year would have made $120,000 but would have paid back $34,000 in management fees.
Troubles for hedge funds started earlier this year when the stock market began to fall on fears of losses in mortgage-related bonds.
HedgeFund.net estimates that the funds lost $93 billion in the first three months of the year alone. But Gradante says things really unraveled in the past month or so, as investment banks, feeling a capital pinch, started to require that hedge funds pay back their loans. The funds typically borrow money to buy stocks or bet against them in order to increase their returns. Hedge funds were then forced to sell their positions, often at a loss, in order to pay back what was owed. What's more, many investors began getting nervous and pulling their money out of the funds. Those redemptions have forced managers to sell as well.
In order to deal with nervous investors and the unpredictable markets, many hedge funds have recently gotten a lot more conservative. David Kostin, an analyst at Goldman Sachs, estimates that hedge funds have moved as much as $400 billion of their assets into cash. Cohen's SAC Capital, which is down 9% this year, has reportedly put half its fund, or $7 billion, in cash. The move to cash makes sense, says Gradante, for the current market. But it may hurt funds over the long haul. "If stocks rebound rapidly, like they did on Monday," says Gradante, "these funds will continue to disappoint investors."