European hedge funds close at record pace as higher costs, poor returns bite

* About 40 pct of hedge funds closures globally in Europe

* Europe funds lag U.S. peer performance for eighth year

* Trend hits investor choice, fund service providers

By Nishant Kumar

LONDON, Feb 16 (Reuters) - Hedge funds in Europe are shutting down at the fastest-ever pace as rising costs, weak performance and a slowdown in the pace of new investment leads some embattled founders to bail out.

Four in every 10 funds which closed last year were in Europe, home to a large number of smaller funds, as the total number of closures rose to a record 370, Eurekahedge data showed, even as other regions benefited from a rise in global industry assets to a record near $3 trillion.

The trend in Europe comes after Eurkeahedge's European funds index rose just 0.7 percent in 2014, way below a 5.5 percent gain by North American peers and notching up an eighth straight year of underperformance.

"Patience of course can only run so deep for many investors," Anne-Gaelle Pouille, a senior portfolio manager at fund of hedge funds PAAMCO, said. "Not all investors, but many investors have struggled to make money in Europe, and when that goes on for a number of years ... money is going to exit."

Among high-profile investors to recently ditch hedge funds, citing poor performance and high costs, were Dutch pension fund PMT and Britain's Local Pensions Fund Authority.

The clean-out of weaker firms in a region with a relatively large number of smaller funds may help those remaining to get a bigger slice of the pie when things turn around, but it means reduced choice for investors and less business for those who service the industry, such as the investment banks who carry out their trades and are known as prime brokers.

INVESTORS RETREAT

Leading the way in closures with nearly a third of the total are so-called equity long-short funds, which bet on falling and rising stock prices. Computer-trading funds and those betting on macroeconomic issues also saw heavy casualties.

The bulk of the attrition was felt among smaller managers, or those managing $350 million or less, although blue-chip names were not immune, with $27 billion Brevan Howard and Bramshott both forced to close funds after poor performance.

Investors pulled a net $13 billion out of European hedge funds in the second half of last year, having invested a net $35 billion in the first half and $64 billion in 2013, the data showed.

And lower returns in 2014 mean the lucrative performance fees charged by hedge funds in Europe shrank at a faster pace than global peers, leaving them with less money to invest in the business and retain key traders and portfolio mangers.

Compounding that financial quandary, smaller funds have found the cost of meeting new rules in Europe, particularly after the introduction of Europe's Alternative Investment Fund Managers Directive (AIFMD), rise more than elsewhere.

"The pendulum towards more onerous rules in the U.S. has stopped swinging. There is, at best, only very limited evidence of this in Europe," said Peter Astleford, a partner at law firm Dechert.

For those who can ride out the current squeeze, however, the future may be brighter, especially if performance picks up, said Michele Gesualdi, chief investment officer at investment manager Kairos Partners.

"This is really the survival of the fittest environment," Gesualdi said. "This year, European funds might surprise people in terms of generating returns."

UNDER PRESSURE

Hedge funds typically take between 1 and 2 percent as a management fee and then a cut of profits of between 15 and 20 percent. Both earners have been under pressure and have dropped since 2008. While larger funds generate enough from management fees to pay for fixed costs, smaller managers may have to use some of the performance fee.

A Citigroup (NYSE: C - news) survey released last month showed a hedge fund needs about $310 million to turn profitable, although some prime brokers say it's possible for some simple strategies such as long/short equity hedge funds to break even with $100 million.

Nearly three quarters of the hedge funds in Europe manage $200 million or less, according to data from Eurekahedge.

The region is home to nearly 37 percent of hedge funds globally by number but hosts just 22.7 percent of the industry's assets, data from Eurekahedge showed, down from 25 percent in October 2007.

With regulation costs rising and many funds burnt after being on the wrong side of a surprise rise in the Swiss franc in January, 2015 has started off in a tough fashion.

Citigroup estimates funds with $350 million or less saw compliance costs rise 31 percent last year and notes they may not be able to break even on management fees alone.

Sandy Kaul, head of business advisory services at Citi, said: "That either is going to have to be covered by principals coming up with more money, or we could probably expect to see a pretty substantial wave of small hedge fund closures." (Editing by Simon Jessop and David Holmes)