As recently as a decade ago, hedge funds were the dominant financial institutions on Wall Street. Known for their high-flying billionaire money managers, their significant minimum investment levels which would weed out all but the wealthiest clientele, and their outrageous fees (offset, the thinking goes, by even more outsized returns), hedge funds were for many in and out of the financial world a representation of all that investment stands for.

Then, the financial crisis of 2008 hit and hedge funds were among the many financial institutions to be decimated by the events and fallout. Whether or not hedge funds can be called a victim of the crisis or one of its many causes (or perhaps both) remains a matter for debate. A report by the Financial Times in 2012, for instance, aimed to debunk claims by those within the hedge fund industry that their firms had nothing to do with the creation of the unsustainable mortgage-based securities which, in turn, set off the economic crisis.

Key Takeaways

  • Hedge funds were once the darlings of Wall Street, attracting billions of dollars and boasting above-average returns.
  • However, the 2008 financial crisis and the Great Recession that followed, put a damper on hedge fund returns
  • High fees and sluggish performance have left some to wonder: is the hedge fund era over? We shall see...

The Immediate Aftermath

During and just after the 2008 crisis, some hedge fund supporters also argued that these firms were not the only ones participating in subprime securities. Perhaps as a result of these positions, the 2008 House Committee hearing on Oversight and Government Reform did not blame hedge funds out and out for the crisis. However, as time went on, some analysts offered alternate explanations which did place hedge funds more squarely at the root of the crisis.

Regardless of the role that hedge funds may have played in generating the crisis, they were nonetheless impacted by it. Along with other areas of the financial world, hedge funds faced the potential for increased regulation and industry criticism in the wake of 2008. According to Value Walk, by the end of 2008, there were more than 5,100 active hedge funds around the world. Interestingly, the first few years after the 2008 crisis did not slow down the launching of new funds; an additional 5,900 funds were launched through the end of September of 2014.

Large-Scale Shifts

The crisis shifted the holdings of many individual investors to institutional investors. Massive institutional investors continued to focus on hedge funds, while individual investors were perhaps more likely to look elsewhere. One need look only hedge fund performance over the past decade to see that the large majority of these firms are unable to produce returns even close to where they were before the crisis. While individual funds continued to thrive, the overall industry has struggled. The third quarter of 2015, for instance, saw net outflows of about $95 billion across the quarter, according to CNN; this marked the largest plunge for the hedge fund world since 2008. As individual investors have grown increasingly frustrated with hedge funds, those funds have occasionally made efforts to try to win back investors who are no longer convinced they can produce the outsized returns they once offered.

One of the most significant shifts in the hedge fund world has been the way that these firms structure their fees. It used to be that hedge funds would generally adhere to the "two and twenty" model, whereby investors paid 2% of their total assets and 20% of their gains in management and operations fees. Some of the most successful funds exceeded these fee percentages, already higher than many other types of investment vehicles. For investors before the crisis, a significant hedge fund fee was acceptable because the fund itself would typically produce returns in the double digits each year. However, returns since the crisis have simply not been that great. Many funds have struggled to even match the returns of the S&P 500 over the past decade. Because of this, some funds have changed their fee structure entirely. Other funds have shuttered; MarketWatch reported that more than 1,000 hedge funds closed down in 2016, for example.

Where Does that Leave Us?

This is not to say that the hedge fund industry is dead. Indeed, many investors still focus their attention on major names in the space, and quarterly filings by some of the biggest names in money management never fail to draw interest among investors of all types. The first six months of 2017 were strong for the industry, according to data by Preqin cited by Institutional Investor. In August of 2018, Bloomberg reported that a portion of the hedge fund industry may have been able to generate stellar profits by going short on metals before commodities were hit hard by trade tensions involving the U.S. Some prominent money managers, like Citadel's Ken Griffin, have managed to maintain their outstanding returns even through the post-crisis phase.

For some analysts, this represents either hope for the continued survival of the hedge fund as a financial institution, or even a sign that hedge funds are making a comeback (the best-ever first-month performance for a hedge fund was Michael Gelband's ExodusPoint Capital Management, launched in June of 2018). Regardless, as investors have grown increasingly interested in low-cost, often more stable types of investment—exchange-traded funds, index funds, and the like—hedge funds have lost some of the position of prominence that they enjoyed prior to 2008, perhaps never to get it back.