Hedge funds gripped by crisis of performance
By Dan McCrum in New York
Hedge funds have a performance problem. Since the turn of the decade, Wall Street’s master stock pickers have spectacularly failed to beat the market.
The crisis of performance comes as the industry is under intense scrutiny over the source of past returns, with SAC Capital facing criminal insider trading charges that threaten to undermine the record of one of the world’s most successful hedge funds. The firm says it has done nothing wrong.
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While many hedge funds fared better than the stock market during the financial crisis, and rode the 2009 recovery back to health, they have been confounded by sometimes violent market moves over subsequent years.
Since January 2010 the average equity hedge fund has produced profits for its investors, after fees, of just 14.5 per cent, according to the research group HFR.
Over the same period an investor in the S&P 500 earned, with dividends, a 55 per cent return: a total which 85 per cent of equity hedge funds have failed to match, finds HFR.
Stock trading specialists at hedge funds fared even worse than their peers managing humdrum mutual funds – 83 per cent of mutual fund managers who invest in large-cap stocks and try to beat the S&P 500 have failed to do so, according to the research group Lipper.
Among all mutual funds investing in stocks, one-third are ahead of the market, and the average investor return is 44.5 per cent from the start of 2010 to the end of June this year, Lipper finds.
The comparison may be unfair to some funds which do not aim to beat the market. Some within the industry argue that hedge funds are behaving as they should, performing better as markets plunge, but lagging behind as they steadily rise.
“We haven’t changed our advice,” said Edward O’Malley, hedge fund consultant for Cambridge Associates, “In the same way?.?.?.?we weren’t advising clients to exit hedge funds in favour of long-only funds after the crisis.”
While mutual funds are restricted to simple activities such as choosing cheap companies, hedge funds typically try to use leverage to magnify returns. They may also use hedging to mitigate losses, or sell short stocks in the anticipation of falling prices.
As pension funds embraced the use of cheap index funds over the last decade, such advantages were pitched as a way for hedge funds to improve portfolios.
Yet the poor performance of the last three years now far outweighs hedge funds’ resilience through the worst of the crisis. Over the past five years the S&P 500 with dividends has delivered average annual returns of 7 per cent, while equity hedge funds have produced just 1.7 per cent, according to HFR.