Hedge Fund-Like Returns Remain Elusive – Will They Ever Come Back?

December 4, 2011

It has been a year that many hedge fund managers would just as soon forget, and with the recent central bank-infused spike in the stock market, any hope of a year-end resurgence has all but evaporated. Having been caught on the wrong side of their long-short positions all year long in a whipsaw market, hedge fund managers found themselves, once again, swimming against a huge tide as they rushed to cover their short positions in an unexpected burst of market exuberance over the European bailout. Having bet heavily that nothing good would come out of the European bailout; their frantic short covering fueled a 500 point surge that left many of them at a loss. This familiar pattern has many investors, and some fund managers, wondering if hedge funds have lost their “hedge” and whether they can ever return to their former glory.

hedge fund performance

Source: www.theworldisurban.com

For the better part of this year the majority of equity-based hedge funds have been posting negative returns while underperforming the S&P 500. That was until the October rally managed to lift the average return into positive territory but still below the S&P 500. The hope was that a year-end rally could salvage an otherwise dismal year. But, in the days and weeks following the October rally, the European debt crisis began to loom ever larger sending the stock market into conniptions. Fund managers began to build short positions in anticipation of all hell breaking loose. Then, when the Fed announced it was going to make a QE-like purchase of Euros to flood the market with cheap dollars, the stock market reacted as if it just received a badly needed fix.  Suddenly, the “short” bubble burst and the hedge fund managers were left holding the bag.

What investors are just now beginning to realize is that the thousands of hedge funds dominate the markets. The big boys have taken over the pool and all of the small guys, the individual investors, have long since run for safety. The computerized insta-trades triggered by “black box” software programs commands as much as 70% of the trade volume on any given day.  So, in essence, they become self-fulfilling prophecies. When the hedge funds are the market, it becomes increasingly difficult to beat the market, which explains the diminishing advantage hedge funds have had over the indexes in recent years.

The hedge fund industry is already in the process of thinning its ranks, but as long as all of the big boys continue to slug it out in the equity pool, investors may be impelled to go find their alpha in other asset pools. The December outflows will be very telling.

 

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