The 3 reasons so many hedge funds got wiped out in 2015

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It has been an ugly year for the hedge fund industry.

As a group, hedge funds have posted dismal returns. The average hedge fund is down 3.72% this year, according to Hedge Fund Research.

The S&P 500, a commonly used benchmark to compare hedge fund performance, is down 2.59% this year.

There have been numerous highly publicized hedge fund closings and redemptions in 2015.

About 257 hedge funds closed in the third quarter, according to a report from Hedge Fund Research. That's up from 200 in the second quarter, which ended June 30.

That took the total number of hedge funds liquidated to 674 through the first nine months of the year, up from 661 during the same period in 2014, the report said.

Multiple well-known funds have been affected. Fortress Investment Group said in October that it would close its macro fund, for example. And in November, Tiger Veda Management said it was shutting down after 11 years in business.

Don Steinbrugge, a managing partner of the Richmond, Virginia-based Agecroft Partners, a marketing and consulting firm for the hedge fund industry, told Business Insider that hedge fund closings tended to pick up for three key reasons.

Dispersion

The first reason is the dispersion in returns among fund managers.

In 2015, there were broad differences with how hedge fund managers played the market, with some of the top performers seeing returns north of 30% and the bottom performers losing more than 20%, according to performance data from HSBC.

Wikimedia Commons"If everyone is kind of generating the same return, it's hard to get fired," Steinbrugge said. "But if there's a large difference between the top-performing hedge funds, you see significantly more redemptions between poor-performing hedge funds, which increases he probability of closure."

Volatility

Another factor that contributes to redemptions, and ultimately closings, is volatility and how the fund manager handles it.

During the third quarter, numerous hedge funds — particularly the activists and the long-short equity funds that were long-biased — saw their portfolios suffer, especially on Monday, August 24, when the Volatility Index (VIX) hit its highest level in four years as markets got clobbered.

"When you have a lot of volatility like you had in August and like you had earlier this month, you have some managers who don't manage it well and the get whipsawed," Steinbrugge said." And if you get whipsawed, taking off your exposure right before the market takes off, you're basically locking in bad numbers relative to your competition and you're going to look bad."

Liquidity

The third factor is liquidity — or illiquidity. That can create an issue when a hedge fund manager is asked to meet a large redemption request.

In some cases, a hedge fund might find it difficult to sell out of positions to generate the cash to meet the redemption request. That can then lead to increased losses, as the assets the fund is trying to shift trade down in an illiquid market.

In some cases, a fund might introduce a delay on paying back redemptions to give itself more time to dispose of hard-to-sell assets. That tactic typically rankles with investors, however, and can create a rush for the exits as investors look to get their money out of the fund as quickly as possible.

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