TRIMMED HEDGES
Funds had a miserable 2015, but their poor performance has been consistent.
“Past performance does not guarantee similar performance in future years.” — Standard disclaimer in the fine print of financial products.
Canadians know William (Bill) Ackman as the audacious hedgefund manager who gained control of Canadian Pacific Railway Ltd. in a proxy fight, ousted the CEO and replaced him with a chief executive of his own choosing.
Ackman is a member not of the 1 per cent, but of the 0.01 per cent, the wealthiest humans drawing breath. He is among the handful of “masters of the universe” whose hedge funds charge the highest fees in the money-management universe.
In 2014, Ackman’s flagship hedge fund, Pershing Square Capital Management, produced an outstanding return for its investors of nearly 40 per cent. But for 2015, Pershing Square will post one of the worst returns in its history, a loss of about 19.5 per cent.
Renowned hedgie John Paulson lost money last year for investors in three of his largest hedge funds. The venerable Carlyle Group once had $8 billion (U.S.) under management. Heavy redemptions due to underperformance of Carlyle hedge funds have reduced that sum to just over $1 billion.
The hall of dishonour of big-time “hedgies” includes most of the $3-trillion industry’s biggest names.
In 2015, David Einhorn’s vaunted Greenlight Capital took a 20-percent loss on assets in its care. Larry Robbins’ Glenview Capital Management posted a loss last year of 17 per cent. Investing giants Bain Capital, BlackRock Inc. and Fortress Investment Group Ltd., all U.S.based, and London-based Nevsky Capital have shut high-profile money-losing hedge funds altogether.
Bottom line: The average hedge fund lost 3.5 per cent in 2015, a year in which the S&P 500 managed to break even
That shoddy performance is not a one-off. Apart from 2011, hedge funds have underperformed the S&P 500 every year since the Wall Street crash of 2009-10, when they astutely bet against banks poised to collapse in the Wall Street meltdown.
To be sure, 2015 was a miserable year for most investors.
The world’s major economies — China, the U.S., Japan, India — failed to post the strong GDP growth that the hedgies expected. Gold and other commodity prices dived instead of recovering. And wild currency fluctuations played havoc with returns.
Yet hedge funds pride themselves on coping with, and profiting from, such volatility. They bill themselves as the extreme contrarian investors.
Actually, a 2015 marked by upheaval was tailor-made for hedgies. It provided an unusually large number of opportunities to hit home runs by betting against consensus opinion, which is the hedge funds’ self-proclaimed raison d’être.
Yet the hedge funds were wrong in their biggest bets last year. This includes their expectation that the world oil price would recover; that China’s growth rate would pull out of its decline; and that certain currencies would rise and others fall.
“Poor performance by hedge funds this year,” Rory Callagy, a senior credit officer at Moody’s Investor Services, told Bloomberg late last month, “in a market environment in which they were designed to shine, may lead to a slowdown in flows into funds and challenge growth across the industry.”
Hedge funds justify their nosebleed fees by treading where others fear to, reaping giant returns for their clients when their audacious bets pay off. At least, that’s the idea. In return, hedge funds charge a lofty fee of 2 per cent for managing their clients’ assets, and rake off 20 per cent of any increase in those assets. The hedgies pocket that upfront 2-per-cent fee regardless of how the funds entrusted to them perform.
After several years of hedge-fund underperformance, institutional investors, including the retirement and mutual funds in which the general public is heavily invested, are wondering why they are paying steep fees for lousy performance.
How lousy? Ackman was just one of the big-time hedgies who invested his clients’ money heavily on Valeant Pharmaceuticals International Inc., the Montreal-based stock market darling whose shares plunged in 2015 on unflattering reports about its unconventional methods of operation.
Indeed, the hedge funds piled into several such “hedge-fund hotels.” Turns out hedge funds can have the same sheeplike mentality as the investing masses when it comes to buying something simply because everyone else is.
Why does it matter how an elite within an elite makes the same investing mistakes as everyone else? Because the aforementioned $3 trillion controlled by hedge funds in the U.S. alone, deployed in the errant ways given to hedgies, is a huge misallocation of the world’s capital.
Life for hedgies will get worse before it gets better. The number of hedge funds has exploded to about 15,000. They are all chasing the same few contrarian opportunities, which thereby cease to be contrarian. Industry growth has also diminished the sagacity of the average hedge-fund bettor.
And the advent of so-called “algorithmic funds” means that one trader’s ill-advised bet ripples throughout the global financial system, creating widespread havoc and losses.
“To mix metaphors,” Nevsky Capital said in explaining why it is shutting down, “butterflies flapping their wings now regularly create hurricanes” that are fatal for hedge funds that cannot “remain solvent longer than the market can remain irrational.”
There has also been a marked decline in the credibility of data published by China, India and other economies, and in that coming from corporations. Which means hedge funds analyzing that data are finding it ever more difficult to place a calculated bet rather than a lotteryticket one.
In a statement of unusual humility, Nevsky concluded: “We are confident our process will eventually work again — for the laws of economics will never be repealed — but for now they are suspended and may be for some time, during which we think it would be wrong for us to be the stewards of your money.”
Hedgies have always promised their clients the sun, the moon and the stars. But they have consistently failed even to outperform the stockmarket averages.
It’s time for the institutions that entrust money to them to rethink placing pensioners’ funds in their stewardship.