Business Analysis: Disillusionment with hedge funds prompts setback at Man Group

Shares in Man dropped 54p, or 3.4 per cent, to close at 1,517p after it emerged that new inflows into its funds had fallen far short of analysts' expectations while client withdrawals came in higher than expected. New inflows were $1.6bn (£900m) in the three months to the end of June, compared with $1.2bn of redemptions.

Stanley Fink, the chief executive, admitted to shareholders at a low-key annual meeting: "It was not our strongest period. Assets didn't go up as much as had been hoped."

Mr Fink explained that the recent strength of the dollar against the euro negatively affected the company's finances by $600m.

Man, as one of only two listed hedge fund managers (the other is RAB Capital) that give a rare insight into a notoriously secretive industry, is generally seen as a bellwether for the sector. Martin Cross, at Teather & Greenwood, said: "Man Group is reasonably representative of the industry... what is happening there reflects much of what is going on elsewhere."

But the group's statement should be viewed in context. Man is coming from a strong position and its blip in fund inflows is nothing like the problems faced by others in the industry. GLG Partners and Vega, two major hedge fund managers, have suffered big losses recently. Another, Bailey Coates, had to close its flagship Cromwell fund after a 24 per cent drop in value. RAB Capital has also seen the performance of its funds plummet in recent months.

That has led some players in the industry, including Charles Beazley, who heads Gartmore's 14-strong hedge fund portfolio, to predict that many hedge fund managers may have to close before long.

Confidence in the industry was severely shaken by the debt downgrades of General Motors and Ford in May. The move wrong-footed many hedge funds, which suffered crippling losses. The GM saga triggered a wave of negative coverage about the sector.

The Financial Services Authority, the City's top watchdog, warned that hedge fund activities might provoke "volatile and potentially disorderly markets" and said it would investigate hedge funds. The Bank of England also weighed into the debate when its deputy governor Sir Andrew Large warned that hedge funds were posing an increasing risk to financial stability.

Hedge funds have mushroomed in recent years to about 8,000 worldwide, managing about $1,000bn. That means that large numbers of funds may be exposed to the same positions and when events do not turn out as expected, large parts of the sector could find themselves caught out simultaneously, with possible big knock-on effects for financial markets.

Man's trading update came as Harvey McGrath, the chairman, was called on to defend the firm against criticism of how it handled the media after the barrage of negative reports about the industry. Man was also lambasted for the performance of individual funds.

One investor asked Mr McGrath: "The editorial position [of newspapers] is to pour doom and gloom over the hedge fund industry. That's damaging to the industry and damaging to Man Group. Has it occurred to you to do something about this? What can be done about the permanent negative press attitude?"

Mr McGrath said he was "very conscious" of the sector's poor image in the media. "The hedge fund industry is characterised wrongly by greed, ego, risk, opacity and non-regulation. Upon inspection it turns out that these things are untrue," he said. "Our approach is to go to great lengths to educate these commentators."

He admitted Man had a leading role to play in the sector. "It becomes a proxy for the hopes and fears and observations about the rapidly growing and intriguing industry," he said.

Mr McGrath launched into a staunch defence of the sector, describing hedge funds as providers of the "alpha", value-added ways of investing money, as opposed to the "beta" investment avenues supplied by the traditional fund management industry.

The gloom surrounding the hedge fund sector has not stopped individual fund managers from pocketing multimillion-pound payments. Jeremy Herrmann, the 35-year-old founder and 75-per-cent owner of Ferox Capital Management, made £11.4m in pay last year. That makes the £3.8m pay package received by Mr Fink last year look positively modest but nonetheless, he is one of the best-paid chief executives in the FTSE 100.

Hedge funds, known for their secretiveness, have also attracted great notoriety for the role they have recently played in corporate takeovers. The biggest shock move came in March when international investors, led by the London-based hedge fund The Children's Investment Trust, thwarted Deutsche Börse's takeover bid for the London Stock Exchange. That sparked a huge anti-capitalism debate in Germany, with the head of the ruling Socialist Democratic Party likening hedge funds and other short-term investors to a swarm of locusts that strip the country bare of money and jobs.

Fund managers say that after a tough March and April, things are looking up again and that June was a strong month for many hedge funds. But some commentators believe that a shake-out in the industry is likely and that only the bigger players are likely to survive. Mr Beazley argues that below $75m of assets, it is impossible to run a fund management operation profitably.

Hedge funds are also likely to become more mainstream once proposals for more regulation are implemented. The Alternative Investment Management Association is setting up working groups to discuss proposals for a code of conduct to alleviate concerns over high risk and the lack of transparency in the industry. The move comes in response to the FSA's investigation into hedge funds.

Guy de Blonay, a hedge-fund manager at New Star Asset Management, said: "The more regulated the industry is, the bigger it is going to become... Retail investors that currently invest in ISAs will one day have access to these types of [hedge fund] products."

Additional reporting by Jack Clough