Continued Stimulus Hurts Hedge Funds

According to the Hennessee Group LLC, the aggregate hedge funds performance for May, as indicated by the HCN Aggregate index, was +1.79% (+7.0% YTD), while the S&P 500 advanced +2.08% (14.34% YTD). Yet another year of “hedge fund” underperformance looks to be in the wings.

Year to date bonds also fell with rumours that the FED may taper its quantitative easing program very soon.  Barclays Aggregate Bond Index displays a retreat of −1.78% in the month.

So, the month of May ended with another gain for the broader equity markets, but unlike what happened in the prior months of the year with day after day of perpetually rising prices, it wasn’t without a fight. In fact, volatility returned as investors become more concerned that this rally may be coming to an end and is out of sync with the real economy.

The latest economic data shows a stagnant world economy still, some 5 years on, struggling to fully recover from the 2007-09 crisis. GDP, employment, housing and consumer spending continue to be cause for concern around the globe, and which may dent company profits and value. Investors are also having doubts over so called Abenomics. Until May, the Nikkei has been on a tear, almost doubling in value in a period of just 7 months pushed on by a weaker Yen but, as Japanese institutional investors ponder the side effects of the massive quantitative easing effectiveness, the rally has most definitely come to an end with the Nikkei no down 20% from its peak just shy of 16,000. Nevertheless, US markets have continued to register record high after high, seemingly just ignoring the continued travails of parts of the global economy such as Europe and China that remain in difficulty.

The increase in volatility during the move did benefit the Long/Short category of hedge funds however and which rose +2.71% in May, beating the S&P 500.

Hedge funds have a poor record of beating the market, completely in contrast to what they are supposed to do and they have been struggling especially since last year since the FED initiated an additional bold quantitative easing program extension. With the effective “central planning” of the FED, the list of hedge funds categories that has the best chance to beat the stock market is reduced to the Long-only category as short positions become very costly in a constantly levitating market. Managers have been bemoaning this very situation, blaming the central bank for distorting risk perceptions. Every stock is a winner in this market and shorting a stock is like taking a shot on your own foot!

During the period between 2007 − 2010, the Long/Short strategy used by hedge funds was able to either beat the market or at least mimic the same results but with modestly less risk, and actually protecting investors downside much better than any other category or the broad market. This was one of the few period where they have lived up to their billing. With the S&P 500 rising with low volatility, what has traditionally been an advantage hedge funds has, given the lower risk profile in equities, become a handicap.

With the long-only strategy bring the best performer so far in the year but still lagging behind the broader market, investors are quite rightly starting to wonder why are they paying a fee of 20% on their gains when they can earn much more buy simply investing in an ETF indexed to the S&P 500.

Under such conditions we can understand why Jeff Vinik is closing his hedge fund business and concentrating his efforts on managing the Tampa Bay Lightning NHL team. Don’t know who Jeff Vinik is? Starting from the next issue of our magazine, we will be unveiling a new feature in Spreadbet Magazine in which we focus upon special individuals within the industry. Can you guess who will be the first? Yes… Jeff!