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.