Why Hedge Funds Remain The Worst Performing Asset Class Of 2016

Tyler Durden's picture

It's been a bad year for hedge funds as a result of significantly underperforming the market, coupled with the biggest wave of redemptions since the financial crisis. Unfortunately, according to the latest Goldman data, there is no reprieve in sight. As the following chart from David Kostin shows, both global macro hedge funds and equity long short funds are the worst performing assets YTD on both a total return and risk-adjusted basis.

There are two main reasons why hedge funds continue to underperform: on one hand correlations across various sectors have soared to the highest levels in the past three years, leading to a plunge in return dispersion making "stock-picking" virtually impossible...

... while on the other hand, the most popular hedge fund short positions have soared in recent months, crushing short books and more than offsetting the modest rebound in the "hedge fund VIP" basket of most popular positions.

And while hedge funds have continued to underperform, several outright sectors continue to dramatically outperform the S&P, most notably IT, followed by Consumer Staples, Telecom and Utilities, even if the latter three have seen some modest weakness in recent months as a result of the pick up in yields.

... leading to the following most recent return by sector, where despite the recent surge in IT, Utilities still have the YTD lead, followed closely by Telecom and Energy.

Shifting away from sectors, and focusing only on valuation factors, we find that size (in this case small is better), high margins and low dividend yield have become increasingly expensive, while on the other end, low momentum, low margins and high volatility are now the cheapest inputs into quant models.

Shifting back out, we then look at the overall market where we find the valuations on both an absolute and relative basis remain especially rich, with the S&P trading at a 17.3x forward PE, and while financials and telecom remain cheap, at 12.6x and 13.9x fwd PE respectively, they are more than offset by the lunacy in Energy stocks which trade at over 43x, while consumer staples is the second richest sector currently.

Finally, putting it all together shows that mutual fund outflows continue, with some $127 billion withdrawn from equity mutual funds, and even ETFs now negative YTD; both of these are more than offset by the $110 billion in inflows in bond mutual funds and ETFs, while as a result of the upcoming change to money market fund regulation, those particular funds keep bleeding cash, having lost some $124 billion YTD. Also worth noting, a marketwide short squeeze as a drive of upside is no longer a key concern as a result of the S&P's median short interest as a % of market cap sliding to 2.4%: the lowest since last summer.

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knukles's picture

So the Saudi's now inject boat loads of reserves into their banks.


How far are we again in seeing the Fed step in to flood the globe with liquidity again.
They can do NOTHING ELSE if there's a soft spot starts leaking again.

BetaGap's picture

Well. So how do you invest your money?

Stockpicking is no choice you say... what else? ETFs? Bonds only? What about Bond picking?

MiniCooper's picture

From the very beginning of the current 'hedge fund' boom I never understood the way in whch they became defined as an asset class. They are JUST leveraged funds that INVEST in bonds, stock, property and derivatives. They may sell short.

In other words they are not an asset class they invest in asset classes but are NOT an asset class themselves.

The whole boom seems to be have been based originally at least on the fact that ordinary investment funds were not alloweed to leverage or go short so they used hedge funds as a way of juicing their returns by quasi leverage and short selling that their own investors would not ordinarily allow under their existing mandates.

It turns out hedge funds are no better at generating Alpha than ordinary investment funds and with central bank intervention increasingly having less and less effect the leveraged Beta masquarading as Alpha has disappeared. 


knukles's picture

And man oh Chitvatz, did I get push back for stating that, years ago.
Told I was just another dumber than a big envelope of coupons bond guy.

hedgiex's picture

Good synopsis. Also, they have thrived and proliferated with the undercurrents of liquidities across less deformed markets while front running of central banks have not been at the center stages. The minorities are now risk focused with algos that trigger positions in shifitng liquid sectors. Their "marketing styles" are jokes while thye have to survive on their views in frint runiing central banks, just one style. For 2%, you can DIY to punt your views on where the CBs are going with controlled leverages. For 2% you pay for greater risks through their need for higher leverages to generate returns assuming that they get it right. 

Heterodox economics's picture

Studies have shown that in any given year, a majority of mutual funds under-perform the market.  Sometimes over 60 percent under-perform the market.

The dirty little secret is that these professional money managers have no real expertise to offer.  There are rare exceptions, such as Peter Lynch.

 My portfolio has outperformed most professional money managers and indexes since 2015.

The way to go is to have a diversified portfolio of at least 8 stocks.  You will do at least as well as market indexes.  And a good chance of outperforming, for you will likely avoid obviously bad stocks, which have to be components of market indexes.

mkhs's picture

Are you a congressional representative or a fed. president?

Heterodox economics's picture

No and no.

Just someone who buys solid, large cap stocks when they are undervalued.


buzzsaw99's picture

when you get 2% of aum every year no matter what there is no such thing as a bad year. hell, i'd take 2% on MY MONEY, I CAN'T IMAGINE how it feels to get 2% on a shitload of OPM.

BetaGap's picture

what about UST? What about a boatload of high rating corporate bonds that have right about that return?

Latitude25's picture

So infrastructure (utilities) IS more important after all.  Just wait until no one can afford to pay their utility bill.

I am Jobe's picture

Looks Like Information Tech only a positive thing. If thisgs don't around they might lay off those folks who has been sold to Hedgies, such as Dell off loading their Dell Software Group 

falak pema's picture

When the shorters loose their pants in front of the CB cabal who does what it takes to keep their targets all flush like turkey fed on steroids before thanksgiving...

The markets don't know the difference between a long and a short and can't tell a shitty hi-yield euro bond from chinese dimsum and american duck soup (assuming the latter will be on the menu) come thanksgiving.

GRDguy's picture

The hedge funds' customers simply said, "Pull it."

ParticularlyStupidHumanoid's picture

Who's to say they aren't all scams?