In this article we are going to list the 10 Biggest Hedge Fund Failures. Click the following link to skip ahead and jump to the 5 Biggest Hedge Fund Failures.
Before we start off with actual biggest hedge fund failures, let’s take a step back and understand what a hedge fund is. Basically, a hedge fund is an investment fund from pooled resources which tends to trade in liquid assets while employing complex financial instruments in order to create better returns than the broader market, as well as hedging the risks of failure.
Hedge funds are distinguished from other asset managers and funds precisely because of the type of investments they undertake. Additionally, hedge funds usually cater to high net-worth individuals and have very high investment requirements.
Hedge funds make use of a wide variety of financial instruments to maximize the possible gain, with each hedge fund employing different tactics. And while they may sometimes be risky, hedge funds tend to provide a positive return on investment regardless of market downturn which is known as absolute return, and they are also considered to be of low risk as compared to retail funds with a high exposure to securities, because hedge funds employ, as the name suggests, hedging techniques to mitigate the risk. These funds generally charge a management fee, which is a small percentage of the net assets, as well as a performance fee.
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While hedge funds have been around for decades, their popularity has recently started to grow substantially, with more and more people ready and willing to invest whatever savings they have. Hedge funds are a significant part of the financial market, with assets under management worth well over $3 trillion. Even during the pandemic, when markets across the world crashed as countries went into lockdowns because of the pandemic, the top hedge funds actually thrived.
In this way, the 20 best performing hedge fund managers actually made $63.5 billion for their investors in 2020, which are the highest gains in a decade, and incredible news in a time where uncertainty has prevailed. However, this also shows the importance of selecting the right hedge fund, as the top 20 were responsible for 50% of all the gains made by the industry in one of the most turbulent of years. Nowadays, many hedge funds even use computers rather than human traders to make investments but 2020 showed that humans outperformed the computers in this regard.
However, because of their size and sometimes ruthless approach that can involve a large activist position in a company and subsequent changes, which can often have a negative impact (like lay-offs or sale), hedge funds are sometimes viewed in not the best light. One recent example of a conflict involving hedge funds concerns GameStop Corp. (NYSE:GME). In case you missed it, GameStop Corp. (NYSE:GME), a brick-and-mortar retailer of video games, consoles, and accessories, has been hit by the growth of eCommerce and its situation was further boosted by the pandemic-caused lockdowns. Seeing an opportunity, some major hedge funds worth billions decided to short-sell GameStop Corp. (NYSE:GME)’s stock, i.e. to bet on the stock going down. However, unexpectedly, an army of Reddit users decided “to fight back” and heavily invested in the stock making it rise more than 400%. This resulted in losses worth millions for hedge funds. Melvin Capital, one of the major short-sellers in this scenario, was down 30% and required an injection of $2.8 billion from Citadel to continue functioning at the level required. Internet users did not stop there and there are many other stocks that are being discussed on the WallstreetBets Subreddit.
Another example of a poor judgement by a hedge fund manager that resulted in losses is Bill Ackman‘s bet against Herbalife Nutrition Ltd (NYSE:HLF). Ackman placed a $1.0 billion short bet on Herbalife Nutrition Ltd (NYSE:HLF) back in 2012 and embarked on a campaign alleging that the company is in fact a pyramid scheme. However, not only did Ackman loose money, but he also got involved in a fight with another renowned investor, Carl Icahn, which was one of Herbalife Nutrition Ltd (NYSE:HLF)’s largest shareholders. Despite the loss of $1.0 billion, Ackman’s short bet hardly counts as one of the biggest hedge fund failures, and it is not even Ackman’s biggest failure as that spot is reserved for his disastrous run with Valeant Pharmaceuticals.
Even the greatest investors make mistakes and some spectacular ones at that. Warren Buffett, the CEO of Berkshire Hathaway Inc. (NYSE:BRK.A), himself has admitted to a number of bad decisions that cost him dearly. You might’ve forgotten, but before Berkshire Hathaway Inc. (NYSE:BRK.A) became one of the largest holding companies in the world, it was a failing textile company. Buffett bet on the company expecting to make a profit from the closure of mills. Later, the now-billionaire investor took control of Berkshire Hathaway Inc. (NYSE:BRK.A), fired the manager, but still tried to keep the textile business afloat for 20 years. Now he says it was one of his worst decisions that might’ve costed him $200 billion.
As you will see from our overview of biggest hedge fund failures, GameStop Corp. (NYSE:GME) is only one of the latest companies to result in a hedge fund flop. There are much more major businesses like General Motors Company (NYSE:GM) that caused trouble for hedge funds.
So without further ado, let’s take a look at the biggest hedge fund failures starting with number 10:
10. Marin Capital
Marin Capital was based in California and had at least $1.7 billion in capital. It used complex financial arrangements such as credit arbitrage and convertible arbitrage to essentially bet on General Motors Company (NYSE:GM). In credit arbitrage, companies can basically transfer credit risk of a payment default to hedge funds. In the case of convertible arbitrage, convertible bonds are issued which are debt instruments that can be converted into stock. These are considered to be low risk strategies, except on the off scenario that the stock’s price dips dramatically, which is exactly what happened with General Motors Company (NYSE:GM), and led to the closure of the fund.
9. Aman Capital
Set up by derivative traders from a top Swiss bank in UBS Gr0up AG (NYSE:UBS), Aman Capital was expected to be a major hedge fund in Singapore. Instead, the fund’s dealings in credit derivatives caused major losses to the fund, the biggest of which was a loss of confidence by investors and the fund closed its doors in 2005, just two years after its founding.
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8. Amaranth Advisors
Next in line in our list of biggest hedge fund failures is Amaranth Advisors. Sometimes, a hedge fund can try its best and simply get suckered into a bad deal which ruins the fund. This is what happened with Amaranth, which had assets under management of around $9 billion, providing massive returns of around 86% due to using convertible bonds. However, some massive bets on derivatives failed to deliver, and the fund made losses of more than $6.5 billion.
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7. Pequot Capital
Pequot Capital enjoyed stellar double-digit returns, which led to it growing significantly in the early 2000s with assets under management worth at least $15 billion. However, it was soon discovered that the reason behind these high returns was insider trading conducted by people in the hedge fund, and the fund was fined $28 million in 2010.
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6. The Galleon Group
The Galleon Group used to have $7 billion in assets under management back in 2009. However, its owner as well as other employees were arrested for insider trading and fraud in the same year and the owner, Raj Rajaratnam, was sentenced to 11 years in prison, while at least 50 others have been convicted or plead guilty in connection with the scheme too.
Please continue to see the 5 biggest hedge fund failures.
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Disclosure: None. 10 biggest hedge fund failures is originally published at Insider Monkey
