Posted on 08/27/2002 4:05:06 PM PDT by dgallo51
Despite being in a bear market, hedge funds struggle to do well
A YEAR ago hedge-fund managers were hailed as the new masters of the universe. One even made a cameo appearance in “Sex and the City”, a New York television series, as an over-confident suitor. (He got the girl, of course.) Hedge-fund managers once talked about a “special skill-set” that distinguished them from mere fund managers. They promised “absolute returns irrespective of market directions”. They put big chunks of their own money into their funds and, as well as annual management fees, took a reward of some 20%—and sometimes as much as 50%—of any gains made for clients.
Today, many hedge funds are performing poorly, and plenty are losing money. Managers now speak as if they are running a widow's fund: they stress the preservation of capital rather than outperformance. Most funds have parked more than a third of the assets they manage in cash instruments, and they have reduced their leverage (that is, the amount they have borrowed to speculate). Funds now admit that falling stockmarkets are proving unexpectedly painful.
An increasing number of hedge-fund managers are giving up. Earlier this month, Bayard Partners in London decided to shut down and hand back the money they were managing. In a letter to investors, the firm described today's markets as a toxic mixture of overvaluation, unrealistic expectations and sentiment-driven volatility. Those are conditions, you would think, in which hedge funds might be expected to thrive—but part of the problem, says Bayard, was a huge increase in European hedge funds in recent years, all seeking absolute returns to justify their fees. The amount of money under hedge-fund management in Europe has risen more than fourfold in the past three years.
Today more than 450 European funds manage $64 billion, about one-tenth of total hedge-fund investment, which is dominated by American outfits. So much money, pursuing relatively few investment strategies, reduces the potential returns for everyone. Fourteen funds have already thrown in the towel this year, says Iain Jenkins of EuroHedge.
Most hedge-fund managers on both sides of the Atlantic will soldier on for the time being. They argue that hedge funds' performance is still good—in relative terms. Last year the hedge-fund index compiled by CSFB-Tremont was up by 4.4%. That was a better performance than equities, but one that merely matched the yield on three-month American Treasury bills. “Last year hedge funds made only one-fifth of what investors have come to expect,” says Jacob Schmidt of Allenbridge, a fund-research group in London. In all, hedge funds this year have barely broken even.
Hedge funds vary so much that figures for the overall industry hardly tell the whole story. About half of all hedge funds are “long-short equity” funds. These buy undervalued equities, short-sell those they deem overvalued and often leverage their fund, too. Long-short equity funds are, on balance, down marginally so far this year. But those with an emphasis on buying shares have lost packets, while those that mainly sell shares short have done rather well. Some funds unafraid to take relatively larger risks have also outperformed. Lazard's European Opportunity fund is up by almost one-third this year, partly thanks to borrowing two or three times its assets.
“Relative-value” arbitrageurs are having a particularly tough time. These try to arbitrage away the differences in prices of, say, two convertible securities (usually, bonds that can be converted into equity). The market for convertible bonds is now dominated by hedge funds, which own more than half the convertibles outstanding. Outside Japan, new issues have dropped, reducing arbitrage opportunities. Further, extreme volatility in credit markets, where spreads have widened, makes credit risk harder to hedge.
A recent study by Narayan Naik at the London Business School confirms a link between the current bear market in shares and the underperformance of various arbitrage strategies, broadly defined (that is, merger arbitrage, distressed investing, relative-value arbitrage and convertible arbitrage). The study shows zero or low correlation of these strategies with stockmarket returns when markets are going up, but a strong correlation when markets are going down.
Hedge funds' obsession with absolute returns stems from their aversion to being benchmarked—that is, judged against others. Yet more than a dozen hedge-fund indices now track the industry. Morgan Stanley, an investment bank, as well as Standard & Poor's, a rating agency, recently announced the launch of their own indices. Such indices are only a rough guide to the most heterogeneous of financial markets. Hedge-fund strategies vary too much to make meaningful comparisons.
Still, hedge funds' focus on absolute returns has also become synonymous with good returns at all times. Hedge-fund managers cannot deliver such miracles and some are no longer prepared to try. “The world,” says Nicola Meaden at Blackstone, an advisory firm, “is very different today than 40 days ago.”
Copyright © 2002 The Economist Newspaper and The Economist Group. All rights reserved.
Ya know why this is..... they're all jumping their billions at the same time trying to do the same thing and wind up moving the market themselves. LOL what a joke.
What's nice about the home real estate market is it's full of unsophisticated investors. Some real estate investing has been converted into stocks so it should be possible in effect to short sell your neighbor’s house if you want to.
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