Hedge funds grew 14.5% in 2007

Despite the recent turmoil throughout the financial markets, the hedge fund industry appears to be alive and well, according to the latest calculations showing that the number of funds grew by 14.5% last year, but some say the data may be suspect. The findings represent the latest indication of the robust size and potential of the ever-expanding industry, now measured at more than 22,000 distinct investment products combining for more than $2 trillion in assets, according to the findings released by PerTrac Financial Solutions LLC, a New York-based developer of asset allocation and investment analysis software. The study used 11 hedge fund databases to attempt to determine the size of the market. Few funds report to more than two or three databases and only one reports to all 11.
However, as always within the hedge funds space, the findings come with a notable asterisk regarding the real quality of the information being gathered and presented in such a loosely regulated industry. "There can be a lot of dirty data so you have to take the information you get from the databases with a grain of salt," said Thomas Orecchio, principal at Greenbaum and Orecchio Inc. in Old Tappan, N.J. Mr. Orecchio, whose firm oversees $450 million in client assets, pays a subscriber fee for hedge fund data, but doesn't think it is the only, or even necessarily the best, way for advisers to do research on hedge fund investments. "A lot of the hedge fund business is still about who you know, and by no means would we use the information from a database to make a final decision on a hedge fund investment," he said.

INCOMPLETE NUMBERS

The underlying message about the quality of industry data isn't lost on the Managed Funds Association, the Washington-based trade association for the hedge funds industry. Representatives from the MFA confirmed that many of the association's members aren't even counted in the market-sizing and performance calculations produced by the databases. "The MFA is keenly interested in having accurate data about the size and scope of the hedge fund industry," said Richard Baker, the association's president and chief executive. The MFA, which has shouldered the responsibility of representing the industry against growing calls for more regulatory oversight, could benefit from the development of a more accurate, centralized database, he said. "We are currently discussing the association's role in developing a central repository for collecting basic information that would capture data such as assets under management, asset flows and number of funds so that we can provide this information with certainty to policymakers, regulators, industry participants, investors and the media," he added. For financial advisers and potential hedge fund investors, the patchwork system of about a dozen primary database firms can serve as an initial research tool and screening mechanism. Beyond that, critics charge, the databases all fall short for reasons ranging from their incompleteness to the voluntary nature by which fund and manager information is gathered. "What you tend to find if you just look at the databases is the hedge funds that have survived and have the best records," said Burton Malkiel, a professor of economics at Princeton (N.J.) University. Mr. Malkiel, who has written several research reports on hedge fund databases, is particularly critical of the survivorship bias that occurs when performance calculations are skewed by funds that stop reporting data. "To get an idea of what hedge funds do for investors, you want more than just what the current hedge funds in the database have done," he said. "I'm not down on databases; I'm down on people who use a hedge fund database to say hedge funds are great investments." While most databases can tout having information from thousands of hedge funds, no database can claim to represent a complete picture of the industry. According to PerTrac's findings, relatively few hedge funds report to multiple databases, and about 12,000 hedge funds and hedge funds of funds report to just one of the 11 databases in the study. "That averages out to nearly 1,100 exclusive funds in each database, underscoring the importance of accessing multiple data sources when conducting serious hedge fund screening and analysis," said Meredith Jones, managing director at PerTrac. The evolution of the database industry has followed the growth and popularity of hedge funds, which began a significant push into more-mainstream asset allocation strategies about a dozen years ago. At that time, most databases were smaller and often linked to fund-of-funds firms or other asset allocation strategies. Over the past five years, there has been some consolidation, which has led to the entrance of firms such as Lipper Inc. in New York and Morningstar Inc. in Chicago into the business. "This is definitely an area I think could be ripe for consolidation," said Ferenc Sanderson, senior research analyst at Lipper.

FEWER DATABASES?

"Ten years down the road, you'll probably see fewer databases than there are today," said Ryan Tagal, Morningstar's director of alternative investments. Though consolidation could lead to a few bigger and more profitable databases, that doesn't mean they could offer the kinds of market- sizing data gathered by associations dedicated to areas such as mutual funds and separately managed accounts. And even if an organization such as the MFA did step up and try to create a single comprehensive database, it would still require the cooperation of an expansive and fragmented industry. "There's just no way to force a hedge fund manager to report data; the SEC already tried that, and the courts didn't allow it," said Hossein Kazemi, senior adviser to the Alternative Investment Analyst Association in Amherst, Mass. "The investor just has to be aware that the databases give you an incomplete picture." Without an independent centralized database, Mr. Tagal said, advisers either will have to "subscribe to all of them or just look at the database that covers the segment of the industry you're most interested in." E-mail Jeff Benjamin at jbenjamin@investmentnews.com.