Monday, May 16, 2016
Emperors New Clothes' Time for Hedge Funds
From the WSJ
LAS VEGAS—Some of the most famous minds in investing convened here this week for an annual celebration of the hedge-fund industry. But, feeling the weight of years of underperformance and an uptick in client defections, the mood was anything but festive.
It sees the conference organizers didnt quite have their story straight on attendance..not too good a sign about how they do on reporting fund manager performance:
You can find comprehensive reporting on hedge fund performance here
One thing that is certain is that hedge funds dont do much hedging. They also dont necessarily have very unique investment strageies.
One widespread strategy is called merger arbitrage NYT:
While last year set a record for the amount of money spent on corporate mergers — $4.7 trillion — this year is so far setting a very different record: the dollar amount of deals that have come undone....Broken deals have whipsawed hedge funds that focus on merger arbitrage, a type of trading that places bets on the likelihood that deals will be completed. As one “arb,” as traders in merger arbitrage are known, described the current mood of the industry: Every day is like showing up unsure of whether to wear a helmet or a diaper.
“You’re definitely seeing a hangover from the M.&A. party from 2015,” said Aly El Hamamsy, a partner in Cadwalader, Wickersham & Taft’s mergers-and-acquisitions group, which occasionally advises arbs. “Things will stay interesting for a few months at least.”
Anxiety is higher than many arbs say they have experienced in years. Merger arbitrage was the worst-performing investment strategy in April
And it seems hedge funds using the merger arbitrage strategy are now loking at ways to hedge their risk by actually doing more research before jumping into trades:
Taking a cue from these troubled deals, some investment funds that do merger arbitrage trading are working with lawyers to pore over agreements to make sure they are placing trades on deals that are not likely to come apart.
Another strategy that has performed poorly of late has been "global macro" which involves trading based on forecasts of global economic events. It shouldnt be much surprise that the world is more complicated and difficult than it seems and exceedingly difficult to forecast. Reversals in trends in oil prices and the dollar among other developments caused losses for these funds. the hedge funds research institute index of macro strategy hedge funds shows a 5 year return of .23% vs 4.7% for the total world stock index and 10.9% for the S+P 500
Despite their reputation for being sophisticated n their research and investing it turns out that hedge fund managers behave pretty much like everyone else showing all the pitfalls n their strategies. They tend to pile into the same trades as others, often simply because it has become a "hot trade" and then show reluctance to adjust to new information that challenges their assumptions. Since the hedge funds take large often leveraged positions when things go bad and they all attempt to reduce the trade at the same time prices drop sharply, liquidity dries up and the losses mount.
The poster child for this scenario has been Valeant. Bill Ackman considered one of the hedge fund geniuses took a huge position in this company. At an annual event open to all willing to make the appropriate charitable contribution (or following the news reports and gossip afterwards) Ackman joined other top managers in pitching their single best idea. Ackman's pitch : Allegran.
Apparenly other investors didnt do much more research other than listen to Ackman's speech and followed Ackman into thte trade. As the NYT reported:
Not coincidentally, big names like Paulson & Company, Viking Global Investors and Brahman Capital have also lost billions, collectively, by betting on Valeant — underscoring a growing phenomenon of hedge fund groupthink. It is a reflection of big-dollar investors chasing too few ideas and getting tripped up when things turn poorly for a company they have set big markers on.
“The bottom line is, hedge fund herding is not going away anytime soon,” said Andrew Karolyi, a professor of finance at Cornell University. “If anything, we are now seeing the early signs that this type of hedge fund herding is spilling over into herding of large institutional investors. To the extent that that spillover grows and expands, then we will be concerned.”
Hedge funds piled into Valeant as the stock soared more than $200 a share last year, even as warning signs about the company’s leadership and business practices began to appear. The stock is now trading around $36 a share, as Valeant prepares to install a new chief executive and races to meet a deadline to file a delayed financial report.
Despite their teams of "highly skilled" and highly paid analysts it seems the hedge funds cut lots of corners follwing the herd (much like the least successful of individual investors.Another exampe is Sun Energy touted by another "top hedge fund manager" David Einhorn at another conference in October 2014 when the stock was trading in the mid teens....the company declared bankruptcy and its stock is now trading at 17 centrs. Other top ranked hedge funds including Greenlight Capial, Glennview Capital and Omega Advisors piled in. Omega Advisors run by long time hedge fund star Leon Cooperman recenly told the SALT conference the industry is "under attack" and mulled leaving the industry in te wake of large redemptions from his fund.
How could this happen ? It seems these top hedge fund managers managing billions of dollars and receiving fees that make them among the highest paid and wealthies people in the world behave much like individual investors trading investment ideas at a cocktail party:
That so many hedge funds remained bullish on Valeant despite months of turmoil — as questions were raised repeatedly about its accounting practices — reflects the difficulty managers sometimes have with changing course.
“We all get lazy and when an idea seems to be working — inertia tends to take over and you stop paying attention,” said James Chanos, the founder of Kynikos Associates and one of Wall Street’s best-known bearish investors. “That’s on full evidence with Valeant and SunEdison too,” he added"
With this track record it is not surprising that institutional investors are rethinking their hedge fund investments discovering that the emperor indeed wears no clothes. A combination of simple index funds and ETFs including those that easily and inexpensively access alternative weighting strategies such as value and momentum...strategies which actually would often profit from the foibles of the "genius" hedge fund managers.
The head of China's investment Company had some pretty harsh words for the hedge fund industry on their investment strategy both generally and with regard to investing in her home country. Leading to a shouting match among some of the wealthiest men (yes the rest were all men) in the world.