Hedge Fund's Annus Horriblis

Hedge funds, the generic names for those private partnerships that generally charge investors 2% management fees plus 20% of any profits didn't have a great 2014.  We noted back in February that by at least one measure of their investment returns these funds returned around 3% versus 13.7% for the S&P 500 last year.   

It doesn't look like 2015 is going to be any better in aggregate.  While the S&P 500 flirts with break-even for 2015 many of these funds are solidly in the red for the year.  Bloomberg, in a recent article noted that:

 "Hedge fund investors are losing patience even with marquee firms as many of them struggle this year, especially those that offer macro strategies or stock funds heavily weighted to rising shares. Some managers have lost money for two years running, while others such as David Einhorn’s Greenlight Capital are suffering declines that rival their worst year. After the weakest third-quarter inflows in six years, the industry could see outflows in the fourth quarter, said investors and bankers who watch the ebb and flow of hedge fund assets."   

Another Bloomberg article notes that some of the biggest losers in this underperfomance are state and governmental pension funds.  

I think we may be on the verge of a serious rethink in how money in this realm is invested.  These so called alternative investment strategies just haven't worked as well as they did a decade or so ago.  The investment reforms after 2008 and too much money sloshing into the space have likely leveled the playing field versus other investment strategies.  I don't think hedge funds are going away.  I do think there is going to be a rethink in how dollars are invested with them and I think there is going to be a compression of fees.  It gets hard to justify that 20% profit return to the funds when there is little or no profit to be had.  

And if you want to add a bearish argument for stocks next year then the compression of the hedge fund universe could mean less extra money sloshing in and out of the markets.  You need more buyers than sellers for stocks to move higher and often it's those hedge funds that are the marginal buyers in strong markets.  There absence could mean a lack of liquidity going forward and fewer funds could mean stocks fall further in corrections as those extra dollars just aren't there to invest.  This isn't my view of things.  For reasons I'll discuss in future posts, I think there's a higher probability that stocks may do better in 2016 than most people expect. But if you want a bearish argument then the compression of the hedge fund industry, especially after a year as horrible as 2015, is one you can likely hang a hat on.

Back Monday. 

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.