Big rallies in US tech behemoths and a series of painful market jolts have disrupted many hedge funds’ attempts to lure back investors who have deserted the sector in recent years.
Hedge funds gained 8.7 per cent on average from January to November 2021, according to data provider HFR. That marks their third consecutive year of gains, but trails by some distance the US S&P 500 index’s 24 per cent total return over that period.
Managers have lagged behind the benchmark US equities index because they tend to hold relatively small positions in tech giants such as Apple, Google parent Alphabet and Tesla, heavyweights in the S&P 500 that have rallied strongly in 2021. Hedge funds have also found it difficult to make money as some bets have been disrupted by often-hostile retail investors.
Inflows into hedge funds have, in turn, proved meagre with performance concerns adding to investor questions about returns and fees.
Patrick Ghali, managing partner at Sussex Partners, which advises clients on hedge fund investments, said there had been a “huge dispersion” in hedge fund performance in 2021. A fund betting on a company’s falling share price might correctly predict a poor set of earnings but then “you might get your face ripped off . . . if retail traders come into the stock”, added Ghali.
Hedge funds have suffered a slow exodus of clients in recent years, with investors more often drawn to the higher returns supposedly on offer in private equity and private debt funds.
However, 2020 marked a rare banner year for the sector. Funds largely survived the market chaos early in the year when the pandemic began to hit markets and went on to post an average gain of 11.8 per cent, widely seen as a strong result in a difficult environment. That raised hopes that investors, who have been growing concerned about high valuations in public and private markets, would flood back in.
But while investors have started to come back, the sums committed so far are relatively modest, and 2021’s returns have not helped.
Investors put a net $24bn into the $4tn hedge fund industry in the first nine months of 2021, according to HFR. That compares with a total of more than $110bn of outflows over the past three years.
Calpers, the $500bn public pension plan, recently told the Financial Times it had no plans to move back into hedge funds after selling out in 2014, citing “problematic” fees.
One big concern is the sector’s lack of so-called “alpha” — industry jargon for performance due to a manager’s clever trades rather than overall market moves. This well-touted ability to pick out the best securities to buy or bet against is the sector’s strongest selling point, but as a strategy it has fared poorly compared with simply buying a cheap index-tracking fund.
Hedge fund managers argue their portfolios are not designed to match an index but rather to do well in all market conditions, but the size of the underperformance last year has nevertheless raised some concerns. Goldman Sachs analysts noted that while hedge funds did not necessarily aim to beat the S&P 500, last year’s returns were also “weak on an absolute basis”.
Hedge fund trades have been hit by a series of market jolts, including the GameStop frenzy, sharp moves in bond yields, and a clampdown on China’s education industry. Managers have also complained that stocks have failed to react to earnings news in the way they have in previous years.
“Alpha [was] terrible,” said Salvatore Cordaro, co-chief executive of investment company Investcorp-Tages, which invests in hedge funds, although he noted that rising markets had “compensated a bit”.
The current trading environment is “extremely treacherous”, wrote Paul Singer’s Elliott Management in a letter to investors seen by the FT, adding that “the most successful ‘strategy’” was to buy “almost anything” using lots of borrowing and follow the latest trends.
Chase Coleman, a ‘Tiger cub’ who previously worked at Julian Robertson’s Tiger Management, gained just 4 per cent in the first 11 months of 2021, after losing about 8 per cent in November in Tiger Global, one of the most successful hedge funds ever.
A low volatility version of Bridgewater’s Pure Alpha lost 3.8 per cent in November, although after gains last month it was up 3.2 per cent in 2021 to late December. Ross Turner’s Pelham Long/Short fund was down about 7 per cent last year to November after suffering losses that month. Melvin Capital, hit during the GameStop frenzy, was down about 40 per cent to November.
Some funds, however, have prospered. Multi-manager fund Citadel gained 24.3 per cent to late December, while rival Millennium was up 12.2 per cent to the end of November. Daniel Loeb’s Third Point gained 23 per cent last year to the end of November, helped by a punchy bet on alternative intelligence lending platform Upstart Holdings and other positions.
London-based quant group Qube Research & Technologies gained about 20 per cent last year and has doubled in size during the pandemic to about $5bn. New York-based Wasserstein Debt Opportunities, which trades junk bonds, made 57.6 per cent to November.
“Good managers have done well, but there have been many landmines along the way,” said Tiger Williams, founder of outsourced trading company Williams Trading.
But some stockpickers have thrown in the towel. Intrinsic Value Investors, a $1.3bn long-only company, told clients in the autumn it would return their money. Founding partner Adriaan de Mol van Otterloo told the FT that “valuations are not attractive to make new investments”. Hedge fund DSAM is also returning money to clients.
The emergence of the Omicron coronavirus strain proved yet another obstacle. Omicron “derailed what was until then a positive trading month”, wrote Roy Niederhoffer’s New York-based quantitative fund company Niederhoffer Capital in a note to investors seen by the FT. Its Diversified fund lost 5.9 per cent in November but was still up 21.4 per cent last year as of late December. Leda Braga’s Systematic BlueTrend lost 8.1 per cent in November, reducing gains in 2021 to 1.3 per cent.
Some managers have been left to reflect on what might have been. Big upheavals during autumn in government bonds, as investors bet that central banks would increase rates to curb inflation, hit Chris Rokos’s Rokos Capital, one of the world’s biggest macro funds, which lost 25 per cent to the end of November.
And while Crispin Odey’s European fund was up 25 per cent in 2021 through November, it had been up more than 100 per cent in early October, before suffering large losses.
“People like Chris Rokos got their heads handed to them” in October, Odey told the FT. “I got my head handed to me, but I got in early” into the trade, which limited overall losses, he added.
Additional reporting by Josephine Cumbo