Poor returns and new evidence about correlation cast doubt over the supremacy of hedge funds
The cult of equity investment may be dead for some faint-hearted losers, but with equity markets this cheap, all you need is a better class of fund manager to profit from them. So say the hedge fund marketers. Give us your ugly duckling of a nest egg and we'll hatch you a swan.
With mainstream markets on the slide, hedge funds have had a good run. Institutional investors have been slow to accept them, but the argument that hedge funds offer low correlation, and higher and more consistent absolute returns is pretty convincing. Yet just when you thought you'd found a decent strategy, along come a whole lot of statistics to foment doubt.
For a start the flow of funds into the hedge fund sector has been drying up over the past year. It is largely marketing hype that keeps the good news story going. Different surveys and polls invariably conclude that projected inflows are likely to grow rapidly, even if there hasn't been much fresh money recently. Investors remember the bit they want to ' about projected inflows.
Next, hedge fund returns have failed to live up to expectations. That might be because expectations were unreasonably high. But annual average absolute returns of 3% look paltry besides the 12%-plus commonly promised. No matter that the traditional long-only managers are under water. Managers are also disappointed. If you have to forego a 20% performance fee and subsist on an annual management charge of 1% or 2%, you may as well run an index tracker.
Then we come to the matter of correlation. Institutions have started to buy alternative investments precisely because they believe this asset class has a low correlation with mainstream markets. But detailed and serious research just released by a French business school suggests this may be a mistake. Most hedge fund strategies do indeed have low correlation when the mainstream market indices are stable or rising, the research shows. But when they start to slide, the correlation rises. So just at the moment you need it most, the unique selling point disappears. Why has this not been detected before? Mainly because genuine data is difficult to come by in a sector long known for its secretive ways. Indeed, secrecy is often cited as one of the competitive advantages. Now even that is under attack from regulators who feel that short selling and leverage are working against market efficiency, and are certainly distorting it.
Even the finest hedge fund talent is feeling the pressure. The stars are switching out their lights and walking out. According to one estimate, fully 20% of hedge funds worldwide folded in the last year. That might be because the manager no longer thought the game worth the candle, or because, to borrow a phrase, they had invested their clients' money until it was all gone.
Some of the biggest names in the industry are admitting that the depth of negative sentiment, the scale of the uncertainties and some of the structural factors in current markets are just too much to deal with. UK hedge fund guru Crispin Odey has dramatically ditched equities and bumped up exposure to bonds to fully 60%, from almost nothing weeks ago.
But there are always optimists. Axa Investment Managers is just the latest house to launch a new product, a market neutral hedge fund designed to exploit statistical anomalies in equity markets. It will be marketed to institutions, private banks and high net worth individuals, and they will buy on the back of promised outperformance and low correlation.
'Truly making a difference'
Avoidance, evasion and non-compliance
From 6 April 2019
Marcus Brookes appointed CIO