A reader thought we had overstated how bad things were in Hedgistan our post earlier this month, Public Pension Funds Starting to Abandon Hedge Funds….More Than a Decade Late, when we described a sea change underway. Readers may recall that CalPERS, often a trend-setter among public pension funds, had decided to end its hedge fund investment program in late 2014. Hedge funds had experienced a net withdrawal of funds in the fourth quarter of 2015, the first in four years. That was followed by an exodus of $15 billion the next quarter. Mind you, this took place against a background of pension funds, endowments, and other long-term investors committing even more funds to alternative investment as a result of inadequate returns in safer options, including making record investments in private equity.
Our reading was confirmed ten days later when the New York City pension system followed CalPERS in terminating its investments in hedge funds, citing “exorbitant fees” and underwhelming results. From Reuters:
“Hedges have underperformed, costing us millions,” New York City’s Public Advocate Letitia James told board members in prepared remarks. “Let them sell their summer homes and jets, and return those fees to their investors.”
Today, as recounted by the Financial Times, hedge fund kingpin David Loeb described in his first-quarter letter to investors how the hedge fund downdraft had only just started:
One of the most powerful US hedge fund managers believes that the industry is in “first innings of a washout” after a string of disastrous market calls inflicted steep losses on many funds…
The first quarter was “one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund,” in December 1996, Mr Loeb said. “There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies.”
Mr Loeb recounted a litany of recent woes for hedge funds. Many have been caught on the wrong side of market swings, such as those related to the Chinese economy and its currency, he pointed out.
Successful bets from 2015 on Facebook and Netflix have soured, and turns in the fortunes of Valeant and Allergan — two companies where hedge funds piled into their shares — “decimated” portfolios, Mr Loeb said…
Funds that had moved into market-neutral strategies at the end of last year were still running high-risk portfolios, Mr Loeb wrote, and when risk assets sold off this year, “market neutral became a hedge fund killing field.”
Event-driven fund management strategies such as Mr Loeb’s were among the hardest hit by outflows in the first quarter, with a net outflow of $8.3bn, according to HFR data. More than half of that was pulled from activist strategies.
It’s not just that the average performance has been poor, lagging the S&P 500. What has particularly hurt the industry is that many of the celebrated players who had the aura of being able to perform well in bad markets, or at least adequately, have stumbled, including Loeb, John Paulson, David Einhorn, and Bill Ackman.
We’ve also gotten reports of similar rending of garments at mid-tier players. A colleague met with a partner in an activist fund who he estimates is worth a minimum of $75 million. Not huge by hedge fund standards but not shabby either. He was angry because in his view, the hedge fund game was over, in part due to the growing investor revolt over fees, and in part due to the Fed making it impossible for hedge funds generally to do anything right (as in so many people are trying to second-guess the Fed’s every twitch that it’s virtually impossible to trade the market well even when you have decent fundamental takes).
So the sense of impending doom in hedge fund land is real. Of course, their version of disaster is having to pare back their house renovation or art collection or political influence plans because their future income is looking to be less rosy than they’d anticipated. But it still couldn’t happen to a nicer bunch. Hedge funds are ultimately arbitrageurs. Even the activists, which is a strategy that can claim to add real value by targeting badly run companies or dodgy reporting, often rattles cages and makes a quick killing rather than effecting lasting change.
While a certain amount of arbitrage is salutary to allow markets to function well, the level of resources committed to and rent extraction associated with hedge funds is completely out of whack with any social value (and in fairness, unlike the private equity industry, hedgies for the most part don’t pretend to be virtuous). So having them cut down to size would be a salutary development indeed.