Wednesday, December 30, 2015

Hedge Funds are More and More like Mutual Funds

Hedge Funds are More and More like Mutual Funds

Some of the best-known hedge funds are going to report dismal numbers in the coming weeks.  According to The New York Times[1], David Einhorn, the founder of Greenlight Capital, and William A. Ackman the founder of Pershing Square Capital Management, are two prominent managers who will face disappointed investors.  Reading The Times coverage and other articles, I am reminded about how much hedge funds have become an ultra-high priced version of mutual funds.  Back in the 80s and 90s a series of value and growth portfolio managers developed stellar track records.  Retail money poured into their funds, and institutions clamored for their services.  After a while, these “great” managers had attracted too much capital, and their performance faltered.  Good luck was replaced by bad luck.

As The Times reports, “Pressure from investors to perform better will be intense for hedge fund managers heading into 2016.”  Setting aside the poor construction of this sentence, Alexandra Stephenson and Matthew Goldstein capture the irrational reaction of investors.    Does anyone think that Einhorn, Ackman, and their respective investment teams weren’t working very hard to find profitable investments in 2015?  Does anyone think that these hedge fund managers will do better in 2016 because their investors are breathing down their backs?  Putting pressure on money managers to perform better may make investors feel better, but it is a waste of time.  If Einhorn and Ackman are luckier in 2016, their returns will improve.  Mutual fund investors have been making the same irrational demands on their portfolio managers for decades.

The article chronicles another common investment problem that has also plagued mutual funds for years:

Hedge funds were hurt, in part, because they piled into many of the same companies — often known as “hedge fund hotels” because of their popularity among hedge fund managers — that suffered sharp declines in shares later in the year. Among them were SunEdison, Williams Companies, Cheniere Energy and Valeant Pharmaceuticals International, which drew negative publicity for steep increases in some drug prices.

When hedge funds began marketing to institutional investors about 15 years ago, they critiqued conventional money managers for piling into the same stocks.   Hedge funds touted their ability to find unique investments that were outside the mainstream.  Today, hedge funds have become too mainstream, and their investment strategies are suffering from the same deficiencies that have plagued mutual funds.  In order to allocate all the money coursing through hedge funds, portfolio managers have to chase the same companies.

In the end hedge funds aren’t much difference from mutual funds.  They promise investors big rewards and deliver disappointment.  However, there’s one big difference: hedge funds charge a lot more for the privilege of being disappointed.


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