Wealthy cut back hedge funds but no firesale

By Laurence Fletcher

GENEVA (Reuters) - Wealthy investors are cutting back exposure to hedge funds after disappointing returns but are not exiting the sector wholesale, and are likely to come back again once markets have calmed down.

High net worth individuals have been key drivers of the rapid growth of the $2.6 trillion industry. Many invested in free-wheeling portfolios well before institutions such as pension funds decided to go in.

But a dire year of performance is presenting hedge funds with their greatest-ever test -- Hedge Fund Research's HFRI index fell 4.68 percent in September, its second worst month ever, taking the year-to-date loss to 9.41 percent.

Still, given the battering equity markets have taken -- the FTSE 100 .FTSE fell 24 percent in the nine months to end-September and has since fallen further -- wealth managers say they are not deserting the asset class completely.

"We're not throwing the baby out with the bathwater," BNP Paribas's (BNPP.PA: Quote, Profile, Research, Stock Buzz) head of private banking in Switzerland Patrick du Saint told the Reuters Wealth Management Summit.

"Hedge funds have been a stabilizer in portfolios ... In relative terms to the equity market they've been much better."

Clients' exposure to hedge funds had stayed relatively stable this year, he said.

Javier Arus Castillo, general manager of Santander Private Bank International, also said clients' weightings had changed little, although they had moved to more liquid strategies such as managed futures -- which bet on trends in global futures markets -- from long/short equity.

'PEOPLE ARE AFRAID'

Other wealth managers, however, say clients have been cutting back allocations more aggressively.

BBVA Patrimonios's chief investment officer Enrique Marazuela said the hedge fund industry was in "meltdown" and said clients had cut back exposure by more than two-thirds.

UBS's head of wealth management in north, east and central Europe, Juerg Zeltner, estimated portfolio allocations to non-traditional assets had fallen from 15-20 percent to levels "substantially lower" now.

"Today for hedge funds it's challenging ... That community is not as regulated as other communities, and people are afraid," he said.

"People are very concerned because hedge funds are perceived to be highly leveraged so when people know things are highly leveraged they guess, 'if they cannot refinance themselves what does that mean for my underlying (investment)?'"

The hedge fund industry's assets are set to fall as clients across the board move to cash, with some commentators talking about total assets shrinking by approximately one-third.  Continued...