A year ago, when we reported that "Hedge Funds Underperform The S&P For The 5th Year In A Row [8]", we thought there is no way this underperformance can continue: after all who in their right mind could possibly anticipate that a "risk-free" centrally-planned world could last for 6 years (well, maybe the USSR).
Back then we explained this now chronic, "new abnormal", regime as follows: "hedge funds are "hedge" funds and appear to have done a great job managing performance over time... but in the new normal world in which we live, where downside risk is irrelevant (until it runs you over), all that matters is return (not risk-reward)."
And yes, as the chart below shows we were wrong: because as of this moment the average hedge fund is not only underperforming the market for a record, 6th year in a row...
[9]
But as Goldman pointed out last night, the return of the entire hedge fund universe as of NOvember 19 is... negative 1%.
[10]
Why? Because virtually the entire hedge fund community was positioned incorrectly going into, and then continuing in 2014, thanks to a massive bond short, which every time it appears to start working, an exogenous shock forces round after round of short covering sprees.
That and, of course, the fact that the Fed has inverted the cost of capital, and the worst of the worst companies can issue junk debt at 5%.
Ironically, it was Goldman which was at the forefront of the sellside crew pushing hedge funds to short the 10Year because any minute now the economy would soar. Instead we now have the BOJ, The ECB, the Fed and as of last night, the PBOC, all engaging in collective easing.
Here is Goldman's mea culpa-cum-explanation:
A combination of macro and micro headwinds has challenged hedge funds in 2014, putting most on pace for another year of disappointing returns. The average hedge fund has posted a negative 1% return YTD, compared with +13% for S&P 500 and +11% for the average large-cap mutual fund. According to HFR data through Nov. 19, macro funds have fared best (+4%), while equity long/short funds have averaged a +1% return
[11]
Low volatility and dispersion have posed obstacles to fund returns this year, and we expect this trend to continue in 2015. Low dispersion, measured as the cross-sectional standard deviation of S&P 500 stock returns, indicates that the potential alpha to be gained from stock picking is small. Historically, low volatility and return dispersion have coincided with poor relative returns of both hedge funds and mutual funds. Market timing has also been a challenge: at the start of 4Q, funds were operating at 54% net long exposure, a new record high, just before the October pullback.
[12]
Strong US economic growth has historically been associated with low dispersion, and we expect both trends will continue in 2015. S&P 500 return dispersion hit historical lows in 2014. While dispersion should be modestly higher in 2015, our forecast of abovetrend US GDP growth suggests that both dispersion and volatility will remain below historical averages, implying another challenging year for fund performance lies ahead.
Unusual underperformance of the most popular hedge fund long positions highlights the challenges from sector positioning. Our VIP list (Bloomberg: GSTHHVIP) has outperformed S&P 500 by 60 bp in 2014 (13.5% vs. 12.9%) after outperforming by 9 pp in 2013 and 7 pp in 2012. One drag on returns has been Consumer Discretionary stocks, which account for 24% of the basket and 21% of net fund positioning (page 13). The list also contains no Utilities, the second best-performing sector YTD. Hedge funds were also overweight the Energy sector at the start of 4Q, even as oil prices had begun to plummet.
Yes, that's all great, however for the average hedge fund PM, who is about to collect zilch on its 20% "incentive fee", Goldman's attempt at justification doesn't buy that Christmas trip to Fiji.
And neither will this. Because while we have been skeptical for the need for hedge funds under a centrally-planned market when the Fed and its central bank peers are the biggest risk managers around, and where one can just buy the S&P for zero cost and outperform 98% of hedge funds, investors are finally noticing.
Which is probably why as Reuters reports [13], the redemption flood has finally arrived and "client requests to take out money from hedge funds rose to an 11-month high in November, data released on Thursday showed."
The SS&C GlobeOp Forward Redemption Indicator, a snapshot of hedge fund clients giving notice to withdraw cash expressed as a percentage of assets under administration, rose to 5.05 percent in November from 3.12 percent in October and the highest since December last year. The index is compiled by fund administrator SS&C Technologies Holdings Inc and is based on data provided by its fund clients, who represent about 10 percent of the assets invested in the hedge fund sector.
Our condolences to the hedge funds, most of them, who for the 6th year in a row failed to outperform stocks: it probably will be your last. But feel free to send your complaints to the No Rat's Asses to Give Here Department at the Marriner Eccles building c/o Janet Yellen and her Princeton- and MIT-educated central-planning peers around the globe.
And look at the bright side: since in the current risk-free, centrally-planned environment, virtually all hedge funds are assured a quiet, painless (one hopes) death, you will at least have a head start on your peers, who are still in the industry betting it all on lucky year 7, and maybe learn an actual skill that has practical uses in the real world aside from just clicking a red or green button.
