Published: Feb 10, 2015 6:01 a.m. ET
Dethroned kings of the market rule an empire of fools
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SAN FRANCISCO (MarketWatch) — Pity the poor hedge fund manager. Times are tough for these former masters of the universe.
An industry that was once the toast of Wall Street is reeling on a multitude of fronts, from insider trading scandals to poor performance to an investor backlash. It’s a turn that’s a cautionary tale for regular investors who have ever greater access to these funds. No longer do many long-term investors in hedge funds seem dazzled by exotic funds claiming too-good-to-be-true returns.
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As The Wall Street Journal put it: «It’s getting so bad, hedge funds are starting to draw comparisons to mutual funds.»
Consider that in the last year:
The nation’s biggest pension fund, the California Public Employees Retirement System (Calpers), announced in September it would exit its $4 billion in hedge fund investments. Ted Eliopoulos, interim chief investment officer at Calpers, said hedge funds don’t «merit a continued role» due to how complex and costly the funds can be.
While the S&P 500 added 11.4% in 2014, equity hedge funds as measured by Hedge Fund Research Inc. gained just 2.1%.
Though hedge funds saw $76.4 billion in inflows last year, the biggest inflows since 2007, don’t be fooled. For one, performance was weak. The composite gain of HFR-tracked funds was just 3.3% (remember the S&P 500 was up 11%). By October of last year, investors seemed to catch on. A majority, 60%, of hedge funds reported outflows during the final three months of 2014. Bloomberg estimated in December that the returns were the worst in three years.
Another reason 2014 was not a boom year for the industry: much of the inflows may be attributed to hedge funds closing shop. Hedge funds closed at a rate not seen since the financial crisis last year. More than 450 funds closed in the first six months of 2014, the latest period for which data is available. Money returned to investors is not considered an outflow, but when investors reinvest that money in a hedge fund, it is considered an inflow.
And it wasn’t just funds run by some kid fresh-out-of business school that shut down. Consider that Emrys Partners, run by Steve Eisman, closed. If Eisman’s name rings a bell, that’s because he was profiled in Michael Lewis’ book «The Big Short: Inside the Doomsday Machine.» Eisman made a boatload betting against subprime mortgages in 2007. He started Emrys in 2012. Wonder if anyone shorted that.
And that’s just the short list. The hedge-fund industry is under fire from investors who are threatening to pull out if funds they invest in either don’t make their benchmarks or lower fees. Just Monday, it was reported that another bank, Morgan Stanley MS, -1.44% is looking to shed its stake in Landsdowne Partners LLP, a London-based hedge fund with $17.5 billion in assets under management.
Morgan Stanley joins Deutsche Bank AG DB, +0.03% , J.P. Morgan Chase & Co. JPM, -0.03% Goldman Sachs Group Inc. GS, +1.14% and others that have either sold hedge fund stakes or are considering pulling out in anticipation of new rules limiting banks’ and brokerages’ risky investments.
Regulation is only part of the story. The reality is that most hedge funds, even those run by star managers, are prone to inconsistent returns. Consider Eaglevale Partners LP. The fund, less than three years old, reportedly includes an investment by Goldman Sachs CEO Lloyd Blankfein. It was founded by a trio of former Goldman employees including Marc Mezvinsky, husband of former first daughter Chelsea Clinton. Eaglevale lost 3.6% last year and 1.96% in 2012. It did better in 2013: up 2%.
But you get the picture: the S&P 500 SPX, +0.96% is up 52% in the last three years (Feb. 10, 2012 through Feb 9).
Still Eaglevale is doing pretty well compared to Paulson & Co. That’s the firm run by John Paulson, who was lionized in Gregory Zuckerman’s book «The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History.» Since the book’s publication at the end of 2010. Paulson has made terrible bets on gold and banks. Last year his fund bought —you guessed it — oil. As of Dec. 8, 2014, Paulson & Co. funds had lost a combined 27% for 2014.
Paulson’s feast and mostly famine routine has cost him. He had $38 billion under management as recently as 2011. Recent reports say Paulson now manages about half of that.
Investors in these types of funds also get the dubious pleasure of paying a «two-and-20» fee schedule (2% of assets, 20% of returns) when the funds actually make money.
Investors should also note that those are the returns and fee schemes one must endure at a fund that isn’t flip-flopping its performance guidelines to juice results, engaging in insider trading or electronically cutting in line on the way to the exchange.
Long gone are the days when hedge fund investing was the cocktail party equivalent of wearing a Rolex for investors. Up until 2007, the hedgies had the cachet and the returns to back up their bravado. Then, investor withdrawals and performance declines accounted for $525 billion in losses for the last half of 2008 — or 25% of all investments.
Overall, the industry may still be able to draw investment from big institutions with too many dollars and too few investment choices as they chase returns. But the glory days of hedge funds are clearly over. Yesterday’s kings today rule over fools.