Today we would like to talk about how the current market slump is affecting hedge funds' performance in creating a solid buffer against the bear market for their clients.
Along lasting decade of low-interest rates and a long bull market spoiled hedge fund managers and led them to drop their guard when the onset of the bear market. The times of easy returns through leveraged bets on high-flying stocks are gone now, and many hedge fund managers are not coping well with the current market conditions.
The purpose of hedge funds business is to earn money in almost any market conditions, balancing long investment exposures with short ones and, thus, hedging against unforeseen situations. To implement this strategy, hedge funds typically charge their clients pretty sizeable commissions amounting, on average, to 2% of portfolio assets and 20% of profits, even though there are even more greedy funds on the market charging 3% + 30% and higher commissions.
The problem is that in the current time of extraordinary volatility, investors' demands for hedge funds to provide stable hedging against the market decline are greater than ever, but many hedge funds falter to deliver an adequate level of hedging, making the wrong asset allocations.
Thus, according to Bloomberg, equity hedge funds are down 15% this year. For example, the super-famous Tiger Global has lost almost 52%l for being heavily loaded with stocks of big tech and other growth companies, which are not doing very well in a period of rising interest rates. Dan Sundheim’s D1 Capital Partners has slumped 28%, and Ross Turner’s Pelham Capital is down 32.5%. Lone Pine Capital, run by Steve Mandel, has seen firmwide assets slump 42%, to $16.7 billion.
Jillian McIntyre, the founder of 221B Capital Partners who once ran short-selling research at billionaire investor Chris Hohn’s hedge fund, in her interview with Bloomberg blames “the poor showing on a diminishing pool of talent”. In a long bull market, there was little incentive for money managers to develop analysts with an aptitude for identifying flawed companies. “In 2021, the absolute number of short sellers declined and may have hit a low point,” says McIntyre. She notes that short sellers have also come under more scrutiny from US authorities, making it a riskier business.
Bloomberg also points out that equity hedge funds underperformed a simple S&P 500 index fund in strong bull market years like 2013 and 2019. According to Bloomberg, about 140 new long-short equity hedge funds have started this year. While this may seem like growth, it compares with an average of more than 550 annually in the previous 10 years, as reported by Preqin, a London-based company specializing in market research for alternative assets professionals.
Managers willing to make concentrated bets or focus on niche sectors such as biotech can still thrive. Similarly, those who maintain a balance of long and short positions also can make their funds less correlated to indexes such as the S&P 500. Bloomberg cites the $24.4 billion Eureka fund, run by London hedge fund Marshall Wace, who told clients last month that its net market exposure was close to zero and reported a 4.2% gain through September of this year, according to investor documents.
It is noteworthy that our partnering company in asset management Sigma Global Management has also posted positive results of its market-neutral, long-short strategy: from August 2020 – September 2022 the cumulative return for Sigma has been 24% vs 9,6% for SPY over the same period, and 6,7% maximum drawdown for Sigma has been -6,71% vs. -24,77% for SPY.