Hedge Funds On Track For Another Poor Year?

Nikolaj Gammeltoft of Bloomberg reports, Hedge Funds Sit Out Stock Market Rally:

Rallying stocks have done little to entice professional money managers back to U.S. equities.

A gauge of hedge-fund bullishness measuring the proportion of bets that shares will rise climbed to 44.5 last week from 43.9 at the end of 2011, holding close to the lowest level since 2009, according to International Strategy & Investment Group. Compared with the price of the Standard & Poor’s 500 Index, managers’ so-called net exposure is close to the lowest since June 2008, the ISI data show.

Speculators have been cutting equities since the index peaked in February 2011 at 54.2, concerned Europe’s credit crisis will spread and curb global economic growth. They stayed bearish after October when the S&P 500 began a 17 percent rally that has restored $2 trillion to the value of American equities.

“Hedge funds have made massive mistakes,” George Feiger, chief executive officer of Contango Capital Advisors Inc., the San Francisco-based wealth management arm of Zions Bancorporation, said in a telephone interview on Jan. 6. He manages $3.3 billion at Contango and Western National Trust Co. “We are less and less willing to invest with these people because at the point when you need them the most, they’re worth the least.”

Record Volatility

Investors have struggled to profit amid record stock market volatility. Hedge funds, largely unregulated investment vehicles that aim to make money whether markets rise or fall, lost 4.9 percent last year as fear that the European sovereign-debt crisis would spread deterred them from buying risky assets including stocks, according to the Bloomberg aggregate hedge- fund index.

The MSCI All-Country World Index slid 9.4 percent in 2011 while fixed-income securities worldwide returned 5.89 percent last year, Bank of America Merrill Lynch indexes show.

The S&P 500 rebounded from last year’s lowest level on Oct. 3 as data on manufacturing, construction and employment spurred speculation the U.S. economy is accelerating. The benchmark index for American equities fell 0.04 point in 2011, the 10th best performance among the world’s stock markets, data compiled by Bloomberg show. The index lost 7.2 percent in September.

Net Exposure

ISI’s index, based on a survey of 35 mostly U.S. hedge funds with about $84 billion under management, tracks net exposure on a zero through 100 scale. Readings of zero show “maximum” short selling, or the sale of borrowed equities with the hope of profiting by buying them at lower prices later, while 100 means “maximum” bullish bets. At 50, hedge funds are deploying a “normal” ratio of long to short investments.

“It is unusual for hedge funds in our survey to remain as cautious on net exposure as they have, given the size of the move in stocks since the summer,” Oscar Sloterbeck, managing director at New York-based ISI, said in an e-mail on Jan. 6.

Hedge funds have reason to be cautious as the euro-zone debt crisis and the U.S. budget debate threaten global economic growth, according to Steve Shafer, chief investment officer at Covenant Global Investors.

“It’s very sensible to have this low level of exposure,” Shafer, who helps manage $315 million at the Oklahoma City-based hedge fund, said in a phone interview yesterday. “The problem is that the low exposure creates the potential for whipsaw, which hurt of lot of hedge funds last year. You get pounded in September and then you miss out on October.”

Manufacturing Reports

The S&P 500 rose 1.6 percent to 1,277.81 last week, its second-best start of a year since 2006, as reports on manufacturing from America to China bolstered optimism about the global economy. It added 0.2 percent to 1,280.7 yesterday. Futures on the S&P 500 advanced 0.9 percent at 6:03 a.m. in New York today.

Buying of equities by hedge funds that have missed out on gains amid an improving economy and record corporate earnings may help propel stock prices this year, said Tim Hartzell of Houston-based Sequent Asset Management.

“The hedge funds are risk takers and they need to come back,” Hartzell, who oversees about $350 million as chief investment officer at Sequent, said in a phone interview Jan. 6.

Please read these hedge fund articles with a grain of salt. The majority of hedge funds (and mutual funds) are mediocre, which is why 60% of them lost money in 2011. And yet, institutional investors keep piling into them with little or no regard that they're paying 2 & 20 for beta or even worse, for managers that severely underperform markets.

As stocks take off, I have a feeling hedge funds and other institutional funds will be chasing risk assets higher all year. They will cave from the pressure of underperforming markets two years in a row. But some hedge funds are taking bullish bets, especially in energy markets. They are taking intelligent risk and top funds will make a killing in 2012.

Those of you tired of paying 2 & 20 for underperformance, please refer to my comment on La Dolce Beta and why it is time to rethink your hedge funds strategy and start seeding hungry, performance driven emerging managers. Importantly, it's not your money, it's pension money, so start making the right decisions on behalf of your plan beneficiaries.

Below, Farhan Mumtaz, an analyst at Eurekahedge Pte., discusses the performance of hedge funds in 2011 and the outlook for this year. He speaks from Singapore with Linzie Janis on Bloomberg Television's "Countdown."