In the latest sign of trouble in the hedge fund industry, once-highflying Bailey Coates Asset Management LLP told investors late last week it would return their money and shut its flagship fund after it racked up losses of nearly 25 percent this year on mistaken bets on both U.S. and European stocks.
The raising of the white flag by London-based Bailey Coates -- just under two years after it first began trading -- comes less than a week after Marin Capital Partners LP, a U.S.-based hedge fund that traded convertible debt and had about $1.7 billion under management, said it would shut its funds and return assets to investors.
A spokesman for Bailey Coates declined to comment beyond saying that the firm would return to investors the nearly $500 million it still manages. At its height, Bailey Coates managed nearly $1.3 billion, although this amount has fallen in recent months due to losses and investors pulling their money from the firm.
Hedge funds, lightly regulated investment pools typically open only to wealthy investors and big institutions, have soared in popularity in recent years due to their perceived ability to make money in both up and down markets.
But the promise of outsized returns has failed to materialize at many hedge funds this year -- and the speed with which investors are withdrawing money means some are simply throwing in the towel as the economics of running the business become less attractive.
So far no individual hedge fund's performance has roiled global financial markets. Instead, some say the industry is simply becalmed, for now.
"Returns haven't been terrible, but they haven't been that good either," said Barry Colvin, president and chief investment officer at Tremont, a fund of hedge funds firm with more than $10 billion under management.
Hedge fund managers, like mutual fund managers, collect an annual management fee. But hedge fund managers make most of their money from rich performance fees that often amount to 20 percent of a fund's profits. Funds can usually collect them only if their performance tops their previous highs.
This means that a fund like Bailey Coates would have to make back all its losses by the end of the year before it could reap a performance fee. In late May, the firm said it had hoped to "continue operating as a business." But it became clear recently that this would be impossible because investor redemptions would probably leave it with assets well below $200 million, according to two people familiar with the fund.
Bailey Coates began trading on July 1, 2003, after Jonathan Bailey and Stephen Coates, two analysts at New York-based hedge fund Perry Capital, decided to strike out on their own. The pair quickly gained a reputation as a hot fund, posting a 20 percent annualized gain in their first six months of operation.
By the end of 2003, assets had grown to about $400 million, and then more than tripled in 2004 to about $1.3 billion, according to people familiar with the firm. New investments poured in, even though its fund returned only about 5 percent in 2004.
But when the Bailey Coates Cromwell Fund showed losses early this year, investors yanked money as quickly as they had invested it. That forced the fund to begin selling assets, which in turn exacerbated losses. That caused more redemptions, and the firm was caught in a vicious cycle. This process was exacerbated by the use of leverage; although the firm had about $1.3 billion of investors' money at its height, it had more than $3 billion invested in the markets.
In just a few weeks in March and April, the firm was forced to sell more than $2 billion in securities to raise cash to meet redemptions and reduce the amount of leverage employed by the fund, according to several people familiar with the matter. This scramble came as the fund had incorrectly bet on U.S. stocks rising in value while at the same time wagering that many European shares would fall. Instead, the opposite occurred, and Bailey Coates was forced to crystallize big losses.
The losses, along with redemptions from the fund, pared the firm's asset base to about $630 million by the end of April, these people said. Further redemptions and additional losses in May reduced the fund's capital to slightly less than $500 million. By the end of May, the firm's loss for the year had grown to 24.9 percent, according to a person familiar with the matter.