Why The Hedge Fund "All-Stars" Are Struggling
May 20, 2010 by Nicholas Vardy
Even as the S&P 500 rose a respectable 7.8 percent through the first four months of 2010, before giving it back in the first week of May amid concerns about Greece’s debt woes, the all-stars of the hedge fund world were having a rough start to 2010.
Moore Capital Management, whose founder, Louis Bacon, has his London digs (okay… more like a palace) right around the corner from me, had only posted gains of 1.58 percent this year—despite climbing to the top of the United Kingdom’s “hedge fund rich list” with a personal fortune of 1.1 billion British pounds.
Last year’s shooting star of the London hedge fund scene, emerging market manager Greg Coffey, who famously left a $250 million bonus on the table at European hedge fund group GLG Partners back in 2008, was down 5.88 percent into mid-March. And having recently sat next to the senior macro trader at Tudor Investments during a dinner at the swanky Carlton Club, I know that the mood at this iconic hedge fund is scarcely better than GLG. It turns out that the Tudor BVI Global fund was down 0.55 percent through mid-March.
No wonder this subpar performance has left investors scratching their heads. These hedge funds aren’t the industry’s one-hit wonders, either. They are, in fact, the “Babe Ruths” of the hedge fund world. After all, with the S&P 500 hitting 18-month highs in April 2010, you probably would think that a monkey throwing darts at a copy of The Wall Street Journal could be making money.
Hedge Fund All-Stars: The State Of Play In Global Markets
Well, if that monkey is an American one throwing darts at American stocks, the approach may succeed. But it’s been tougher for the monkey’s more cosmopolitan cousin.
The reality is that outside of the United States stock market, global stock markets haven’t done much in the last six months.
While the U.S. stock market rose a solid 15 percent during the last six months through April 2010, the MSCI EAFE Index—a stock market index that reflects market performance of developed markets in Europe, Australasia and the Far East—was clearly in the red for 2010. The formerly high-octane BRICs (Brazil, Russia, India and China) are struggling this year. And the weak performance of global markets masks a now seemingly distant but stomach-churning 15 percent sell-off in global stocks within the span of two weeks in January and February.
Hedge Funds Struggling: Here’s Why
Unlike U.S. retail investors, global macro hedge funds—or “multi-strategy funds”—aren’t necessarily focused solely on the U.S. stock market. And opportunities to make money outside of the U.S. stock market have been limited.
Yes, the dollar is up, and the euro and the British pound are down. Sugar soared for a while, but then collapsed. But gains on those trades have hardly made up for the cost of being whipsawed in and out of the market by sharp sell-offs in January and again in early May this year.
For retail investors, “buy and hold” remains the dominant investment mantra. And it’s also the strategy that has worked best over the past 14 months. But after a paradigm-shifting 2008, hedge funds are understandably skittish. They are (rightly) focused on the downside risks—whether financial contagion from Greece or another “Black Swan” event which they cannot predict.
Top hedge funds are also struggling because they look at risk in a fundamentally different way than investors schooled in the ways of "buy and hold." They are focused on the downside to a degree that is hard for most investors to imagine. At SAC Capital, if a portfolio manager is down 5 percent, he loses half of his money under management. If he loses 10 percent, he is shown the door. Apply that same standard to your favorite broker and see how long he’d last.
The experience of 2008 is also why many top hedge funds went on the defensive after the sharp sell-off in January. And they have been scrambling to recover ever since. Recent volatility in global financial markets notwithstanding, after an eight-week rally in the U.S. markets through the end of April, the sharpness and suddenness of the January sell-off seemed to fade into distant memory. As John Kenneth Galbraith observed, “the financial memory is very short.” For U.S. investors glued to the non-stop video game that is CNBC, “fear” rapidly transformed into “greed.” Of course, the big sell-off in the first week of May should serve as a reminder that risk management is as relevant to individual investors as it is to big institutions.
The bottom line? Yes, staying "dumb and long" in the U.S. stock market while ignoring the dips has been the single-best investment strategy over the past year. And any monkey, throwing darts at The Wall Street Journal would have outperformed the world’s top Market Wizards over the course of the last 14 months.
But as any old trader on Wall Street will tell you, “never confuse brains with a bull market.” And as any hedge fund manager will add: “If you pay peanuts, you get monkeys.”
Nicholas A. Vardy
Editor, The Global Guru
P.S. If you want to keep up with my latest insights on developments in fast-paced global markets, you can now follow me on Twitter on @NickVardy or on my new blog, NickVardy.com.