Hedge funds face profit headache in 2013

Hedge funds' glory days seem a long way off as they head into a tricky 2013, with bumper profits likely to remain elusive in markets now dominated by political and central bank action.

Speakers at the Reuters Global Investment 2013 Outlook Summit said the $2 trillion industry, which has disappointed investors with below-market returns this year and losses last year, faces a headache making money in an environment where markets are choppy and not as buoyant.

"We're now (in) a world where we recognize that the ability to make money is a lot more difficult and there aren't that many people who can do it. There simply aren't enough, it just doesn't exist," said Saker Nusseibeh, CEO of Hermes Fund Managers.

"Lots of hedge funds are not making even a positive return. They should be doing 4-5 percent. And they're not ... Suppose it's the smartest people with the smartest models, and they've had 10 years' practice. If you give me 10 years I'm sure I can come back and play the piano badly."

Hedge funds made double-digit returns in seven out of nine years between 1991 and 1999, according to Hedge Fund Research's HFRI index, and made returns of more than 9 percent every year between 2003 and 2007 inclusive amid rising markets.

However, their secret sauce of 'alpha' - profits due to a manager's skill rather than overall market moves - has been hard to find in the 'risk-on, risk-off' environment where markets can be more influenced by the words of euro zone politicians and central bankers than companies' fundamentals.

Funds have lost money in two of the four calendar years prior to 2012, according to HFRI. This year the average fund is up just 2.24 percent to November 23, according to the HFRX index, well behind a 12.1 percent gain in the S&P 500 index .SPX.

Some star managers have been able to thrive in this environment, betting on anything from Greek debt to rising stocks to asset-backed securities.

CQS Chief Executive Michael Hintze, one of the industry's most influential managers, has returned 29 percent from his Directional Opportunities fund in the first 10 months of the year and told the summit he sees a "target-rich environment" in 2013 with opportunities shorting bonds using credit default swaps.

However, fund executives say there may be fewer opportunities for the industry - which has ballooned in size over the past 10 years - as a whole to exploit.

"Alpha delivery can be very difficult. If you have risk-on, risk-off it can be more difficult," William De Vijlder, CIO of BNP Paribas Investment Partners, said.

"There are less big valuation discrepancies around," he added. "You think of 2006 or 2007 and then you think of early 2009 and huge valuation gaps. So perhaps now this is a more difficult (environment) ... When you have something that is very much central bank-led it's much more difficult."

However, De Vijlder said long-short funds, which bet on rising and falling prices but which have struggled as their bets often move in the same direction - may profit as correlations between stocks in an index come down.

Meanwhile regulation such as curbs on naked credit default swaps, short-selling bans and greater reporting requirements could all make life tougher for the sector.

Giordano Lombardo, group chief investment officer at Pioneer Investments, said his portfolios had adopted some hedge fund-like techniques in recent years, such as protecting against losses by buying hedges.

But he said that increased regulation could make life tough for many funds.

"The sector is going through a maturity crisis. Post (being a) teenager you have to decide what to do with yourself," he said.

"The hedge fund world is going to be more regulated and follow more the rules or the general investment industry. That will force out of the market players not willing to play the game in that way."