Wednesday, February 8, 2012

Hedge Fund Managers Thrilled to Death?

Mia Lamar of the WSJ reports, Hedge Funds Added Small Gains in January:

Hedge-fund performance perked up in January, although continued to lag the major stock indexes, according to industry adviser Hennessee Group.

Hennessee's hedge fund index rose 2.5% for the month of January, less than the Standard & Poor's 500 and Dow Jones Industrial Average, which posted gains of 4.4% and 3.4%, respectively. The Nasdaq Composite Index climbed 8% last month.

Still, the advancement in January comes after a dismal 2011 for the hedge industry, which has been battered by swiftly changing sentiment on Europe's sovereign-debt crisis and other macro concerns around the world. Hennessee's hedge fund Index fell 4.27% in 2011, marking the worst year for hedge funds since 2008.

"It is encouraging to see a respectable gain even with managers conservatively positioned," said Lee Hennessee, managing principal of Hennessee Group.

Equity long/short strategies were among the best-performing strategies last month, as the Hennessee Long/Short Equity Index advanced 2.47%. Stocks pushed higher in January, led by technology and financials, as U.S. economic data continued to show signs of improvement.

It's hardly surprising to see Equity long/short funds posted the best returns as stock markets rocketed up in January. In other words, once more, it's all about beta stupid!

There is however more good news for hedgies. Harriet Agnew of Financial news reports, Long/short hedge funds to gain from correlation decline:

Stock correlation within sectors has dropped significantly this year as markets have rallied, providing a boon for long/short equities managers who buy and sell companies based on fundamental analysis of their individual merits.

Giles Worthington, a portfolio manager at RiverCrest Capital, said: "Correlations are falling with quite a powerful force and diversity in stock returns is rising. This is good news for stock-pickers as once again investors are considering the difference between a high-quality and a low-quality company.”

The attached chart, published yesterday on Business Insider, illustrates the 21-day stock correlation within the Russell 1000 Index. It shows that correlation has fallen from a peak of about 0.75 in September to about 0.2.

Worthington said that the key short-term driver of this has been the European Bank's three-year provision of liquidity through its Long Term Refinance Operation that was announced in December.

He said: "The LTRO has significantly reduced the tail risk in the markets. The huge risk of financial implosion has gone away for the time being. Last year the markets were dictated by macro calls and now they are focusing on stocks."

For many managers, the drop in correlation is a welcome respite from the high correlations driven by macroeconomic newsflow that characterised the markets for much of last year.

Looking at valuations alone would have created the wrong idea: defensive growth stocks trading at high multiples performed well, while cheap cyclical stocks perceived as value investments suffered losses.

At times company share prices moved not on individual valuations but on the perceived country risk or currency risk of the issuer. Late last year, for example as investors became more concerned about France's triple-a rating potentially being downgraded, French stocks were sold off indiscriminately, in line with the market's perception of an inherent risk of investing in France.

According to data provider Hedge Fund Research, the average hedge fund gained 2.63% in January, with equity strategies leading the way, up 3.84%.

Among long/short equity managers, many of last year's biggest losers rebounded strongly in January. Crispin Odey's Odey European fund is up double digits this year, while Lansdowne Partners' UK fund gained 5.7% in January, investors said.

Worthington said that although stock selection detracted from his fund's performance in December, by January it accounted for 60% of the returns.

However, he also sounded a note of caution. He said: "The market always starts the year quite buoyant as companies invariably come out with good expectations and they have a full year to disappoint.

"There's been bit of a 'dash for trash' too - in the US, for example, the top-performing stocks this year underperformed by 40% on average in 2011. A lot of the highly-leveraged, high-cyclical companies have bounced as portfolio managers have rotated out of more defensive names."

According to Credit Suisse strategists, the rotation ratio in January was 76%. This means that around three quarters of sectors either outperformed in January 2012 after underperforming in 2011 or vice versa, the highest level of rotation since 2001. Banks are the most striking example of this, they said.

The chart was first reported by Business Insider blog.

In other news, Finalternatives reports that Goldman Sachs' former special situations chief will launch his new firm's maiden hedge fund next quarter along with another Golman and Tudor vet:

Richard Ruzika, global head of special situations at Goldman between 2007 and last year, founded Dublin Hill Capital in Connecticut with Lance Bakrow and Joe Howley. The Connecticut-based firm will unveil its Global Macro Fund in an effort to take advantage of the strategy's current popularity, HFMWeek reports.

Ruzika was co-head of global macro trading and global head of commodities at points during his 29-year career at Goldman.

Bakrow, another Goldman Sachs veteran, is a founder of Greenwich Energy Partners. Howley, a Tudor Investment Corp. veteran, was managing director of natural gas trading at Sempra Energy.

Whenever you read veterans from Goldman and Tudor are getting together to start a global macro fund, it's worth meeting them and discussing their new fund. Ask them lots of tough questions but this is the type of new fund I like investing in.

I've been tough on hedgies lately. Someone accused me of "waging war against them". Nothing can be further from the truth. While I've seen many "malakies" in the hedge fund industry, including nonsense within pension funds investing in hedge funds, I still believe that excellent hedge funds are worth investing with.

Do I believe in paying 2 & 20? A lot less than I used to. Why? Because most hedge funds are mediocre and the large ones are mostly asset gatherers. Moreover, institutions can replicate a lot of hedge funds strategies internally and if you're a large pension fund like ATP, you got a large enough balance sheet to beat them at their own game at a fraction of the cost. It's stupid to get eaten alive by hedge fund fees, making them rich for gathering assets.

Tonight I had dinner with some former colleagues. We all worked in hedge funds before. We were discussing how stupid it is for large public pension funds to pay millions in fees to hedge funds instead of developing alpha internally. These guys are sharp money managers and know all about hedge funds. One of the guys can slice and dice any hedge fund strategy and reverse engineer it. The other is a credit specialist who has done his share of due diligence on hedge funds and knows all about alpha and managing money.

We all feel that too many institutions are wasting their money on hedge funds. Save your money, develop alpha talent internally and don't waste your time and resources chasing hedge funds. And if you are going to venture into hedge funds, seed some alpha managers who are performance driven but don't take an equity stake!!!

All these institutions investing in hedge funds, including the Caisse and Ontario Teachers', should publicly disclose how much they've disbursed in fees since inception of their hedge fund programs. My guess is hundreds of millions. Sure, they've invested in some great funds, made money, but also got clobbered in others which you'll never hear about. The point is would they have been better off taking the ATP approach, investing in internal hedge funds? Results speak for themselves.

Below, Ann Pettifor, George Kapopoulos and Matina Stevis discuss the prospect of a Greek default on Al-Jazeera. Debt discussions in Greece have stalled on pension dispute. If Greece defaults, you'll see macro news take over again, and correlations rise across all asset classes (except bonds).

If all hell breaks loose, hedge funds will suffer. If a deal is struck, watch out, a massive liquidity rally could mean many hedge funds will underperform. Both scenarios would be bad for hedge funds, especially the former one. At the end of the day, most hedge funds are a lot more like mutual funds and pension funds in that they desperately need the big beta boost to make money.

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