“Hedge fund Bernanke” crushes real Hedge Fund returns

Hedge funds are usually referred to as the “king of all investments”. In reality, only a few fund managers have actually produced consistent stellar performances over the last two decades. however.

The best portfolio managers have produced a whopping 20% to 30% gains on average per years, whereas as a whole, the hedge fund industry has been able to produce an average performance of just 7.4% per year since the beginning of the new century. Although, to be fair, the S&P has essentially been on a road to nowhere over this period.

High net worth individuals and also institutions have been seduced by the potential of above average performance as well as the long/short basis that these funds typically operate on and so making them attractive in terms of hedging risk, in particular systematic risk. The hope of protecting the downside risks is what has been attracting billions of dollars from high net worth individuals and from several institutions including the, historically more staid, endowment and pension funds. But the picture has changed recently, and not even the ‘highly skilled’ Steve Cohen of SAC Capital and his “network of experts” (cough, cough) can beat the best of fund managers – none other than Mr “Helicopter” Ben Bernanke and his S&P 500 fund!

At a time when hedge funds show an average performance of 4.7% YTD, Bernanke’s inflated S&P 500 outpaces the hedge fund industry by over three times or, looked at another way, hedge funds are now over 12% below the S&P 500 YTD. Oops!

With Bernanke effectively capping market risks by injecting trillions of cash into the U.S. economy whilst keeping interest rates near zero for a prolonged period of time, he is distorting investment choices. It seems that every American is an investor once again in the market at this point and there is no negative news that can affect the stock market. Indeed, every negative piece of news is taken lightly and any loss derived from it is soon reverted into a new record high. As for the most shorted stocks – those with short interest above 50% – they are really excelling in terms of performance. There’s no way anyone can make money from shorting stocks at the moment, so great is the momentum behind the market. For now…

In the supposed ‘no-risk economy’ in which we now live, any attempt to hedge has just result in a reduced performance. It is like using sunglasses at night! You can feel comfortable with them but they are redundant in terms of sunlight protection at night. The exact same is happening in the market. Hedge funds traditionally protect for risks that just no longer exist as a consequence of Bernanke and his merry men of ultra dovish monetarists. It is therefore no surprise that they’re under-performing the S&P 500.

Over the last four years, hedge funds have in fact underperformed the S&P 500. This is a direction consequence of short positions taken in the face of the unprecedented monetary easing.

Can you guess what has been happening? The pressure for performance is so high and hungry investors are beginning to think: why pay 20% in performance fees to a hedge fund manager offering a 4.7% performance while the S&P 500 is offering 17% with no fees added? That’s a fair thought process..!

Hedge funds will likely reduce short positions and potentially move to a net long exposure. In fact, this has been happening in recent weeks with our story about them turning uber bullish – just before the market rout in recent days (see here – http://www.spreadbetmagazine.com/blog/has-the-dumb-money-moniker-been-switched-and-is-the-top-in-n.html)!

It seems that very few people in the market are prepared for the next major rout. Households have too much in the market & hedge funds will be largely on the long side. We think it’s time to start taking the other side of this trade, hence our short play on the Nikkei recently (see here –  http://www.spreadbetmagazine.com/blog/the-japanese-bubble-reaches-new-technical-extremes.html). “Benny Boy” is also running out of bullets…

According to “the squid” (aka Goldman Sucks) data, it seems that hedge funds are already adapting to the new risk-free world. Diversification is no longer one of their strengths. When compared with large-cap mutual funds, hedge funds appear much more concentrated. On average the top 10 holdings of a mutual fund account for 37% of total holdings while they amount to 63% in hedge funds. One example of this concentration is Paulson’s portfolio. His top 10 holdings amount to 55%, with a single holding – SPDR Gold Trust – absorbing 19% of his portfolio value. We all know how that is playing out too… So much for alpha and 2 and 20 justification.

If you want to read our assessment of the 2013 landscape and that is playing out pretty presciently, then click the image below for your free book.