While no one hedge fund index is comprehensive. all the reports to date point the same way: the hedge fund industry lost its clients a lot of money in 2008.
While you can blame the horrid results on the dreadful environment across a host of asset classes, a very real sense, the funds became victim of their own success. And I don’t mean via the burgeoning amount of capital that reduced the returns in formerly attractive strategies.
No, what hurt hedge funds was their pursuit of institutional money. In the stone ages, when hedge funds were the province of wealthy individuals, they could do what ever they wanted to as long as it was legal and delivered outsized returns over time. In other words, they did not have to adhere to an investment style.
One of my colleagues, Amar Bhide (then at McKinsey, now a professor at Columbia Business School, at one point in between head of proprietary trading at a Wall Street firm) pondered in depth why hedge funds could outperform. He concluded that it was because, unlike other money managers, who had to operate within comparatively narrow confines (say large cap US equities or emerging markets bonds), they could go wherever they thought the best opportunities lay. And perhaps as important, they had no obligation to be in a particular market.
But the fund consultants that advise pension funds and endowments insist that hedge funds conform to a particular “style”, say event driven (what used to be called risk arbitrage), distressed debt, emerging markets, 130/30, convertible arbitrage, global macro…..you get the picture.
The problem is you have to stay in your style box no matter whether you think the opportunities are great this juncture or not. You are just as locked into your style as the US large cap equity manager. You cannot dabble in another strategy even if (for whatever reason) you have the competence to go there too.
Or consider something more mundane: if you were in a strategy that required you to be long, or limited the degree to which you could short, well by golly, you dare not go net short even if you saw the freight train bearing down on the markets in 2007. You aren’t supposed to trouble your pretty head with shorts, If the smart fund consultant thought his client should have some of his money in short strategies, he’d recommend the allocation and pick the manager. And that in turn limits the client’s and funds’ ability to adapt if the tectonic plates make a sudden move. (But you dear institution with money are supposed to take the long view, not try to market time, and allocate your fund according to some hocus pocus).
Funds that are opportunistic are generally limited to the family office market (and small endowments that are close to wealthy families). The fund consultants steer clients away from them, no matter how good their track record. Their success, after all, flies in the face of the fund consultants’ approach.
Hedge funds lost 18.3 percent in 2008, their worst year on record, as managers misjudged the severity of the biggest financial crisis since the Great Depression.
A gain of 0.42 percent in December lessened the average loss for the full year, according to Hedge Fund Research Inc.’s HFRI Fund Weighted Composite Index. The decline was the largest since the Chicago-based firm began tracking data in 1990…
The decline by hedge funds last year compared with the 37 percent drop in the Standard & Poor’s 500 Index, including reinvested dividends, the benchmark’s worst showing since 1937. Commodities slumped 33 percent, according to the UBS Bloomberg Constant Maturity Commodity Index of 26 contracts.
The worst previous performance by hedge funds was in 2002, when they lost 1.45 percent while the S&P 500 tumbled 23 percent. Hedge funds returned 9.9 percent in 2007.
Among the major investment strategies, equity hedge funds lost the most last year, an average of 26 percent, Hedge Fund Research said. Event-driven funds, which invest in companies going through changes such as mergers and spinoffs, lost 21 percent. Macro hedge funds, which can bet on securities from commodities and interest rates, returned 5.7 percent….
Funds that invest in hedge funds lost 20 percent last year, Hedge Fund Research said. Tiger Select Absolute Return Fund LP, a fund of funds overseen by Morgan Creek Capital Management LLC in Chapel Hill, North Carolina, lost 51 percent in the first 11 months of the year, according to an investor letter.
“They’ve shown not to have added any value above the broad market,” James McKee, director of hedge-fund research at Callan Associates Inc., an investment consulting firm in San Francisco, said of funds of funds. “I don’t think it will be the death of the fund-of-funds industry, but there will be a lot of pressure for change.”