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What "Smart" Money? Hedge Funds Underperform Market For Seventh Straight Year

Tyler Durden's picture




 

Every year we point out that under central planning, alpha no longer matters since it is all about how much liquidity, er beta - smart or otherwise - central bankers can inject. And every year we tell those who have a burning itch to be in the rigged market to just buy the SPY - with the Fed as your chief risk officer, there is no need to hedge, and when the Fed finally loses control, no covering of shorts will be allowed anyway.

This overarching philosophy was confirmed overnight when Goldman reported that "hedge funds are on pace to lag the market index for the seventh straight year in 2015."

But... but... one should compare hedge funds to their benchmark not the S&P, underperforming hedge fund managers will scream. Hey, whatever lets you sleep at night, just don't tell that to Claren Road which was outperforming its benchmark, but was down a measly 5.6% until mid-August when it got 50% of its AUM redeemed.

Petulant pleadings aside, this is how the "average" hedge fund is busy earning its 2 and 20, or 0.5% and 10% as the case is increasingly becoming.

After roughly matching the S&P 500 through most of 1H 2015, funds lowered net exposures as the market declined in late June and failed to benefit as the index rebounded in July. The typical fund has returned +0.5% YTD, with equity long/short funds rising 1.3% and event-driven funds falling by 2.0%. Our VIP basket of most popular long positions has outperformed the S&P 500 by 44 bp (+3.3%).

 

Hardly stuff to write home about. But how do hedge funds manage to underperform the broader market for 7 years in a row? Simple: by shorting all the same stocks - thereby inducing massive short squeezes when just one is forced to cover, and going long all the same strategiest, such as Growth And Momentum. To wit:

Several major factor trends have marked US equity performance in 2015. Most notably, stocks with the fastest growth and most momentum have outperformed their counterparts YTD and particularly in the last four months. Our long/short Growth Micro Equity Factor (Bloomberg ticker: GSMEFGRO), which compares the performance of sector-neutral quintiles of S&P 500 firms with fastest vs. slowest earnings and sales growth, has risen 6% since the start of May. Our long/short Momentum Factor (GSMEFMOM), which is not sector-neutral, has returned 27% during the same period.

 

 

Growth and momentum are also the largest factor exposures of hedge fund favorite long positions, as tracked by our Hedge Fund VIP list (Bloomberg: GSTHHVIP). Exhibit 7 shows the correlation between long/short equity factors and the performance of our Hedge Fund VIP list vs. the S&P 500. After growth and momentum, hedge fund favorite long positions also exhibit characteristics such as low dividend yield and high volatility.

 

 

The problem with the above is that as we pointed out yesterday, momentum as the preferred "strategy" of choice is finally failing, and when it fails, it gets messy:

The outsized performance of 12-month momentum stocks has now pushed valuations of the winners to the highest levels we have seen since the financial crisis. Being priced for perfection renders the group even more vulnerable to a change in leadership. Momentum, by definition, tends to work very well until it breaks, but the magnitude of absolute and relative losses post-break has been extreme: from 1986 to now, cycle peaks in 12-month momentum have been followed by extremely weak momentum returns in the next twelve months: relative underperformance of 16ppt, and absolute losses of 25% on average.

Needless to say, a 25% crash to end what has been the worst period of broad market underperformance for the hedge funds industry in history, may be just the catalyst the wealthy investing public needs to end its infatuation with the asset class and paying HF billionaires a few hundred thousands dollars for every hour of their time just so they can underperform buying a simple SPY ETF form the market and paying 0% and 0% for the privilege.

 

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Thu, 08/20/2015 - 09:04 | 6446711 Brazen Heist
Brazen Heist's picture

Its well known that passive investing strategies outperform actively managed funds on aggregate.

Thu, 08/20/2015 - 09:08 | 6446723 bigdumbnugly
bigdumbnugly's picture

and soon the ultimate passive investment strategy of putting it under the mattress will even outperform the other passive investment strategies.

Thu, 08/20/2015 - 09:17 | 6446749 Brazen Heist
Brazen Heist's picture

Cash and hard assets look good right now, but when shit gets crazy and more volatile....that's exactly when some great opportunities arise. Crisis is crisis for some, but for others, opportunity.

Thu, 08/20/2015 - 09:19 | 6446756 JRobby
JRobby's picture

Hedge fund - avoid regulation, pay yourself well.

And they throw $$$ at them. Got to be in style!

Thu, 08/20/2015 - 09:09 | 6446726 junction
junction's picture

If not for QE, hedge funds would have done even worse.  The guys who set up  hedge funds have their yachts but where are the customers' yachts? 

Thu, 08/20/2015 - 09:04 | 6446712 TeamDepends
TeamDepends's picture

Word is the Cash In The Mattress Fund outperforms from now on mm-hmmm.

Thu, 08/20/2015 - 09:08 | 6446718 JustObserving
JustObserving's picture
Hedge Funds Underperform Market For Seventh Straight Year

Some people take eight years to learn their financial lessons

No one has ever lost money underestimating the intelligence of the American public

Thu, 08/20/2015 - 09:11 | 6446729 knukles
knukles's picture

What's "smart" are the 2% fees.  Smart for them, not anybody else. 
Way back before the dinosaurs died out I remember a whole bunch of run of the mill bond salesmen setting up hedge funds. 
These guys had Zero as in naught, zilch, nada investing skills.  They were bond peddlers.
But, 2% is 2%.  None remain in the business.
Then the public funds about the time of the Spanish Influenza plague all piled in.  Great job, folks!  BTW, have you funds marked all those "deals" including your last venture into real estate to market, yet?
Or started accounting for your liabilities with Projected Benefit as opposed to Accumulated Benefit obligations numbers?
I didn't think so.

We the public been Fogled again.
No toy in the box

Thu, 08/20/2015 - 09:13 | 6446732 Rainman
Rainman's picture

" The good part, William, is that no matter whether our clients make money or lose money, Duke & Duke gets the commissions. "

                                ~ Mortimer to Billy Ray

Thu, 08/20/2015 - 09:15 | 6446740 slightlyskeptical
slightlyskeptical's picture

I think people buy hedge funds to protect themselves from rapidly falling markets. Since the markets have basically only gone up it stands to reason that they thay have underperformed.

Thu, 08/20/2015 - 09:23 | 6446766 Albertarocks
Albertarocks's picture

I agree completely.  This is actually a great performance by hedge funds because... had they kept up with these incredibly dangerous markets, tick for tick, then they would have to have been 100% exposed to the whims of the jackals who run Wall Street.  Anybody who did that with his clients' money should be hanging from a tree somewhere.

On the other hand, hedge funds should have the class and the balls to warn their clients when to just get the hell out.  If they don't, they should be hanging from a tree somewhere.

Thu, 08/20/2015 - 09:33 | 6446795 Government need...
Government needs you to pay taxes's picture

At some point, don't the Wall Street cadre turn against the QE-politicians as AUM declines with the shift to passive mgmt, ETF-heavy strategies?

Thu, 08/20/2015 - 09:46 | 6446843 Downtoolong
Downtoolong's picture

"equity long/short funds rising 1.3%"

My short term bond fund yielded 1.7%, and I don't have to listen to David Topper tell me how smart he is to manage it.

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