Hedge fund assets under management plummeted by $88 billion last year, according to research by eVestment, a firm that provides software to institutional investors. It was easily the deepest decline in assets for the industry since the financial crisis a decade ago, eVestment said in a report published Thursday.
Extreme turbulence across financial markets exposed glaring performance issues that have dogged hedge funds for years.
"Investors were again reminded that the industry is not necessarily full of exceptional managers," wrote Peter Laurelli, eVestment's global head of research. "There is no disputing the numbers."
That realization hit a crescendo last month, when the S&P 500 suffered its steepest December decline since the Great Depression.
Jittery clients pulled $19.6 billion out of hedge funds that month alone, lifting annual withdrawals to $35.3 billion, eVestment said.
Hundreds of hedge funds shut down
The withdrawals were punctuated by several large funds deciding to liquidate or convert to family firms early in the fourth quarter. When those funds closed, they returned capital to investors.
More than 400 hedge funds were liquidated through the first three quarters of 2018, according to HFR.
"We have been in a bull market for the last 11 years, so now that this is ending, the wheat is being separated from the chaff," said Ole Rollag, managing principal of Murano Connect, a firm that connects fund managers to allocators. "There are many fund managers, but only some of them are good."
It's not a new trend. Nearly 3,000 hedge funds were shut down since the beginning of 2015, HFR said. And hedge fund assets plunged by $112 billion in 2016.
The problem is that the performance of many hedge funds has not lived up to the expensive fees that they charge.
For many years, most hedge funds charged a flat fee of 2% on total assets and an extra 20% on any profits earned. But poor performance has forced hedge funds to rethink the pricey "two and twenty" fee structure that eats into client returns.
EVestment said the hedge fund aggregate index fell by 5.2% in 2018, narrowly trailing the S&P 500's 4.4% decline. Hedge funds did beat the S&P 500 in the fourth quarter, though they still lost money.
"In theory, hedge funds are supposed to be able to make money in up or down markets," said Ian Winer, a former hedge fund executive who is now an advisory board member at Drexel Hamilton.
Tech, oil trades implode
Performance issues were exposed by the fact that hedge funds piled into crowded stocks like Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL). Crowded positioning can exacerbate losses when everyone decides to sell at the same time. The tech trade blew up last year when the Nasdaq careened into a bear market.
Equity hedge funds tumbled by nearly 8% in 2018, including a 4% loss in December, eVestment said.
Hedge funds were also hurt by the extreme turbulence in the oil patch. Oil prices shot higher most of the year before plunging into a bear market in the fall, dealing heavy losses to some hedge funds.
Commodity hedge funds fell by 6% last year, eVestment said.
Brenham Capital, a Dallas hedge fund that bet on energy stocks, closed its doors in late November. Founder John Labanowski blamed the "gut-wrenching" decision to liquidate on the boom-bust nature of oil.
"The cycle continues to get shorter and more violent," Labanowski wrote in a letter to clients.
"Our team fought the good fight and had great success at times but the difficult environment finally took its toll on the Fund's returns and me personally."
$3.2 trillion of hedge fund assets
Don't feel too badly for hedge funds though. The industry still manages a stunning $3.2 trillion. And 42% of hedge fund managers were able to raise net capital last year, eVestment said.
Some firms, especially ones using macro strategies, adeptly navigated the challenging market conditions.
For instance, the flagship fund at Citadel, the $30 billion hedge fund run by billionaire Ken Griffin, was up 9.1% last year, a person familiar with the matter told CNN Business.
Earlier this week Griffin closed on the $238 million purchase of a Manhattan property at 220 Central Park South. It marks the most expensive price ever paid for a home in the United States.
Still, the winning funds were hard to find in 2018.
Winer said that too many firms are "masquerading" as hedge funds. They don't adequately hedge themselves, essentially making them leveraged long funds.
"When the market is up, they do okay. But when the market's down, they get killed," Winer said. "Investors have finally said, 'Why am I paying two and twenty for a fund that isn't too different from buying the S&P for nothing?'"
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