Daniel Loeb, founder and chief executive of Third Point © Bloomberg

One of the most powerful US hedge fund managers believes that the industry is in “first innings of a washout” after a string of disastrous market calls inflicted steep losses on many funds.

Daniel Loeb’s stark comments, in his first-quarter letter to investors in his fund Third Point, come as institutions such as pension funds are questioning the value of investing in hedge funds.

The first quarter was “one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund,” in December 1996, Mr Loeb said. “There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies.”

Mr Loeb recounted a litany of recent woes for hedge funds. Many have been caught on the wrong side of market swings, such as those related to the Chinese economy and its currency, he pointed out.

Successful bets from 2015 on Facebook and Netflix have soured, and turns in the fortunes of Valeant and Allergan — two companies where hedge funds piled into their shares — “decimated” portfolios, Mr Loeb said.

Third Point has not been spared mistakes and has lost 2.3 per cent this year, compared with a gain of 1.3 per cent for the S&P 500, according to the letter. Since the fund started 20 years ago, it has returned an annualised 15.8 per cent, more than the S&P’s 7.3 per cent, the letter said.

Third Point was among hedge funds knocked after new tax rules derailed Allergan’s planned $160bn takeover by US-based Pfizer was jeopardised by the US administration’s crackdown on “inversion” tax deals.

An index of hedge fund performance lost 0.7 per cent in the first quarter, and clients pulled $15bn from the industry, the worst quarter in seven years, according to Hedge Fund Research. Many of the industry’s largest and highest profile funds suffered the worst losses, including Bill Ackman’s Pershing Square and funds from Lansdowne.

Funds that had moved into market-neutral strategies at the end of last year were still running high-risk portfolios, Mr Loeb wrote, and when risk assets sold off this year, “market neutral became a hedge fund killing field.”

Event-driven fund management strategies such as Mr Loeb’s were among the hardest hit by outflows in the first quarter, with a net outflow of $8.3bn, according to HFR data. More than half of that was pulled from activist strategies.

An index tracking performance of those types of funds was unchanged for the quarter, recovered from a drop in January of 3.2 per cent, HFR data show.

Poor performance has perturbed investors already disgruntled with their hedge fund investments and worried that they have failed to justify their cost. New York City Employees’ Retirement System this month cut its hedge fund programme, citing a lack of transparency and exorbitant fees.

With many funds taking a more cautious approach to investing, and some facing disruptions from client redemptions, there are opportunities for those who can take advantage, Mr Loeb wrote.

“As most investors have been caught offsides at some or multiple points over the past eight months, the impulse to do little is understandable,” Mr Loeb wrote. “We are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets.”

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