Just two weeks ago we explained [4] how when there is only one driving factor for market performance and "too-many coat-tail clinging asset managers chasing too few real alpha opportunities" then problems can arise. Critically, we showed the correlation between the S&P 500 and hedge fund returns has never been higher and is approaching 1. So it is refreshing that the Treasury Department agrees in a recent report that this "herding into popular assets" by asset managers could pose a threat to the US financial system.
Via Bloomberg, [5]
Money managers could pose threats to the U.S. financial system when reaching for higher returns, herding into popular asset classes... and can contribute to asset price increases and magnify volatility during sudden shocks, a report by the Treasury said today.
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“A certain combination of fund- and firm-level activities within a large, complex firm, or engagement by a significant number of asset managers in riskier activities, could pose, amplify or transmit a threat to the financial system,” the Treasury’s Office of Financial Research said in the report.
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“The council will review the study closely as it considers potential next steps relating to asset management activities and firms,”
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Exchange-traded funds “may transmit or amplify financial shocks originating elsewhere” by pooling assets into illiquid investments.
“Herding into more illiquid investments may have a greater potential to create adverse market impacts if financial shocks trigger a reversal of the herding behavior,” the OFR said.
Well given the charts below... we'd say the systemic threat has never been higher...
Hedge fund managers have become high cost version of their index-tracking ETF brethren...
[6]
And performance advantages have dwindled...
[7]
as Stan Druckenmiller previously noted:
On why Hedge Fund managers are less successful:
“There are too many, there were eight to ten back then. Somehow, 9000 people are pricing their product off of eight to ten people historic performance. I noticed a lot of the smart early investors and hedge fund clients were leaving, but they were more than replaced by state pension funds, sovereign wealth funds and so far they have been perfectly happy to get returns that our early investors would have never tolerated.”