Deephaven Capital Management was a hedge fund that reached about $4B assets at one time. They announced today they are closing shop, selling themselves for $7MM plus potentially $30MM more (depending on fund performance and how much money leaves), to Stark. They still had over $1B in assets, so as one analyst said, the $7MM is 'paltry'. I used to work there, and as they were kind enough never to sue me I have nothing but nice things to say about them. But they highlight an interesting hedge fund dilemma.
Say a fund is down 35% or so, as many funds were in 2008. If you expect a volatility of 12%, and hope for a Sharpe of 1, it will be 3 years before you make any incentive fees again (the 20% of profits). That's because a high water mark means you only make the 20% after your investors are back to their high water mark. Now, if you own the fund, you are probably wealthy enough to stand 3 years of no cash flow from the basic fund. You probably also get a lot of non-cash utility from owning your fund. Thus, I can see why you still keep it going if you are an owner-manager. In Deephaven's case, they were 51% owned by Knight Capital, meaning, the main owners were not much involved in day to day management, and have other core businesses to manage, ones they actually control day-to-day. So, if you are down about 3 years of expected returns, for an outside owner, it's a good time to exit.
I suspect many funds are facing similar cost/benefit calculations. If a fund is down 30+%, most of those who don't feel a real stake in the action will have a big incentive to shut down, because of these high water marks.