London's status as global powerhouse strong

By Svea Herbst-Bayliss, Analysis

BOSTON (Reuters) - Hedge funds are ready to set records this year, but their achievements are not the stuff managers or investors want to brag about.

"The bubble has popped and there is going to be a lot of pain," said Bradley Alford, the founder of hedge fund advisory firm Alpha Capital Management. "There will be a massive reassessment of where money should go."

Until recently, it was a red-hot industry known for its double-digit returns, money pouring in and billion-dollar paychecks. But a growing number of firms are now facing investors asking for their money back as staff worry whether there will be another paycheck, amid terrible returns.

As pressure from poor returns and redemptions builds, more funds than ever will be forced to liquidate, investors said. Many expect the $1.8 trillion industry's estimated 10,000 funds to be winnowed down by a few thousand in a few years.

"This year is going to be really ugly," lamented one manager, who did not want to be identified because his investors do not know yet about his double-digit losses. "One day you are off 2 percent and, before you blink, you are down 20 percent. This year is just unpredictable and crazy."

Tallying the first quarter's wreckage, including the collapse of hedge funds Peloton Partners and Sailfish, investors agree things will get worse before they improve.

They are not much more optimistic about the private equity industry, where deals requiring big debt financings are getting done less often.

"At this point, when the liquidity spigot is turned off pretty much, its a brave new world and one in which the private equity game rules have changed dramatically," said Michael Holland, chairman of private investment firm Holland & Co and a former partner at Blackstone.

Mounting job losses coupled with the deepening housing crisis may have already pushed the U.S. economy into recession and certainly frightened Wall Street banks to loan less to hedge funds. For many managers, borrowed money, or leverage, had been the lifeblood for strong returns and, with those gone, analysts expect investors may be tempted to put their money with managers who charge less than hedge funds' hefty fees.

In the face of sagging returns, the new trend in hedge funds will not be how much they pull in, but trying to stop the money they have from fleeing, investors and managers said.

In February, investors sent only $8.4 billion to hedge funds after adding nearly three times that amount in November, according to data from research firm TrimTabs.

"Hedge funds are going to become the kind of hotels where you can check in, but you can't check out," Alpha Capital's Alford said, explaining that managers are desperately adding restrictions to keep all the money from leaving at once.

Hedge fund investors and managers will be discussing these topics at next week's Reuters Hedge Fund and Private Equity Summit in New York, London, Singapore, Hong Kong and Tokyo.

Managers are right to fear outflows as industry analysts forecast the average hedge fund likely lost between 5 percent and 8 percent in the first quarter.

Those numbers will be released in a few days, but because hedge funds, unlike mutual funds, report returns on a voluntary basis only, the data may paint a misleading picture. Failed hedge funds' heavy losses are no longer counted and losing managers often do not report either, skewing the data.  Continued...