Hedge Funds - Mastered by the universe

Jul 11th 2012, 16:16 by Buttonwood

..IT IS turning into another difficult year for the hedge fund industry. Data from GlobeOp found that, in June, funds suffered the largest withdrawals in assets since October 2009. Eurekahedge found that hedge funds suffered their fourth consecutive month of negative returns in June; in the first half of the year, they eked out a return of 1.3%, compared to a 3.7% gain for the MSCI World index. That follows a 3.6% decline in 2011. for those investors who picked a fund-of-funds, with the accompanying extra layer of fees, a 0.4% return this year followed a 5.4% loss in 2011. In short, investors have lost money over the last 18 months.



The marketing claims of hedge funds have changed over the years. In the 1990s, the glory days of George Soros and Michael Steinhardt, it was argued that hedge fund managers were the "smartest guys in the room" who could produce superior returns. In the 2000s, as equity markets faltered, it was claimed that hedge fund managers delivered absolute returns; they tended not to lose money. But then they lost almost 20% in 2008. So now people talk about the uncorrelated returns hedge fund managers achieve.



There are lots of claims, and counter-claims; in this area; lots of studies that try to account for factors such as survivorship bias and volatility. But a few things seem pretty certain.



1. Many hedge fund managers are smart, and some managers may be a lot smarter than the average investor. The difficulty is in identifying those investors in advance.



2. There are some generally uncorrelated strategies but these niches can be quite small, and consist of illiquid assets. As a result, the lack of correlation with the big asset classes may be partly caused by the slowness of price adjustment in such assets, since deals are less common. But the corollary is that it is difficult to exit such strategies in a crisis, with the result that there are occasional steep drops in valuations.



3. For the bulk of the industry there is likely to be a reasonable correlation with indices such as the S&P 500. As the industry gets larger, this correlation is likely to increase and it will be harder for the average manager to outperform.



4. Hedge fund managers will thus be subject to the same constraint as mutual fund managers; that returns are equal to the index minus costs. And since their fees are higher, the result will be disappointing returns for the average investor.



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Source :
http://www.economist.com/blogs/buttonwood/2012/07/hedge-funds