This data “will be met with dismay by the hedge fund industry.”
“Alternative Investments” were the Holy Grail. They promised big returns that would be independent from the gyrations of the stock and bond markets. Hedge Funds and Private Equity firms marketed them to wealthy individuals and institutional investors, such as pension funds.
“Feel the power of Alternative Investments – B.A.M.” That’s how Credit Suisse advertised it on its website back in October 2013. It was so irresistible that I took a screenshot of the ad, to be used at an opportune moment, and now is that moment:
This was the heyday of Alternative Investments. QE Infinity was making everything possible. Yields on bonds had plunged to near nothing. Prices of most assets were soaring. Risks no longer existed and hence weren’t priced into anything. And anyone could make big returns. But that’s like so 2013….
“Low interest rates, steep commodity losses, and intense equity market volatility contributed to a challenging environment in 2015, resulting in a wide dispersion between the best and worst performing funds,“ explained Kenneth Heinz, president of Hedge Fund Research (HFR) in its report about the hedge fund debacle that 2015 had become.
So hedge funds across the $2.9 trillion industry were in the red for December and ended the year 2015 down 0.85%, according to HFR’s fund-weighted composite index. It was only the fourth year since 1990 that the index ended up in the hole.
They got hammered by hedge-fund favorites: the entire energy sector, distressed debt when it became the “opportunity of a lifetime” in late 2014 and early 2015, junk bonds of all stripes, Apple, which is down 28% from its high in 2014, and a slew of other companies….
And they charged a lot in fees for the privilege, as high as 2% of assets under management, plus a 20% slice of investment profits.
Who has figured out already that this equations isn’t working all that well? The California Public Employees’ Retirement System. CalPERS, the largest public pension fund in the US, decided a while ago to eliminate its hedge fund program, as part of its efforts “to look for ways to reduce risk, complexity, and costs,” as it said in its just released report on the fiscal year ended June 30, 2015.
It practically bragged about it. That hedge-fund elimination process, along with “the diligent work to negotiate more favorable terms for CalPERS with our external managers,” cut its costs for the year by $217 million.
And it did better than the hedge fund industry: it earned a measly 2.4% on its assets. The report blamed “the impact of tepid global economic growth and increased short-term market volatility,” along with the strong dollar that had eaten into international investments.
Other institutional investors are eyeing a similar hedge-fund demolition program in their portfolios. A survey by research group Preqin, to be published in its annual report on the hedge fund industry later this month (and reported on Sunday by the Financial Times) found that only 25% of institutional investors are planning to increase their hedge fund exposure, while 32% are planning to slash it.
In the survey a year ago, 26% of institutional investors were planning to increase their hedge fund exposure, with only 16% planning to cut it. But in the middle of 2015, Preqin’s interim poll first indicated that more investors were planning to cut their hedge-fund holdings than were planning to increase them. And now the trends has strengthened.
This data, as the Financial Times put it, “will be met with dismay by the hedge fund industry, which had hoped volatile stock markets would encourage investors to seek alternative sources of return. It is also likely to add extra pressure on hedge fund fees.”
To add insult to injury:
The downbeat figures … also show that one in three investors were disappointed by returns from their hedge fund portfolio in 2015 and have less confidence in future returns than they had a year ago.
That momentum of disappointment and hedge-fund elimination is picking up steam. The promise of “alt investments” has run aground on high fees and in some cases spectacular losses. After a phenomenal boom, there are nearly 15,000 hedge funds. But according to Don Steinbrugge, managing partner at hedge-fund market and consulting firm Agecroft Partners, many of them will hit rough waters in 2016, and closures “should also be at an all-time high.” The era of hedge-fund glory and “alt investment” dazzle has peaked.
At least, they didn’t blame China. Read… This is What Happens after PE Firms Get Through with a Retailer
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Assuming the institutions understand what they are investing in, how come they invest in intermediaries. Why nipot have their own hedge funds?
Hi from Oz. In Australia we have nearly A$2 trillion of private retirement funds invested on behalf of individual superannuation fund members through a range of for-profit, self-managed, corporate and “industry” (aka trade-union controlled, non-profit) funds. I am a member of an industry fund, and I have been watching the returns on the various ‘investment options’ that are offered. One such option is called ‘Australian Sustainable Shares’, another is called ‘International Sustainable Shares’, which presumably avoid ‘bad’ stuff like mining and tobacco companies, but like ‘good’ stuff like ‘renewables’. Only trouble is, despite a serious global downturn in mining stocks, for the last couple of years my fund is showing lower returns for both the ‘sustainable’ investment options. In the past I thought about investing in these so-called ‘sustainable’ options, because for a while they seemed to be doing better than vanilla shares, but now I’m glad that I didn’t. FYI – if you can want to check this out look here: http://www.unisuper.com.au. cheers,
As a former industry participant l’d like to make a few observations. First, the 2 and 20 compensation scheme was designed when funds were much smaller. A $200 million fund with about 8 employees used that 2% for rent, overheads and a very modest base salary for employees. All other compensation had to be earned from the 20% performance fee. But once hedge funds became large, $10 billion plus behemoths the entire arrangement changed. Now that 2% brought in $200 million per year regardless of performance. A clever manager/owner would spend half that amount running the fund, pocket the rest and retire rich in a decade or less. These perverse incentives encouraged asset gathering at the expense of performance. I believe what we’re seeing now is a reversal of this trend.
Many of these hedge funds are merely extensions of the large brokerage firms/banks. They are an easy way to off load the insider trading to a smaller entity which isn’t subject to as much regulation. The big firms “invest” in the small firms and can move substantial profits, the insider trades, into them without too much notice on the part of regulators. The regulators don’t want to notice what’s going on, they want to preside over a profitable industry. It makes the regulators and the regulations look successful.
How’s CalPers going to fund the existing and future retirees with this kind of return?
I’d heard the state of California takes tax revenue to shore up CalPers short fall in this matter. Is this true?
Yeah sure of course, as Mr. Tilles points out the industry is a behemoth and what hot- shot trader would ever go to a mutual fund, that’s taxed, when he or she can open their own Alt Investment Fund and demand the two & 20, plus get taxed at far, far lower rates (thanx to our own Senator, Charles ‘Chuck’ Schumer). That’s freakin’ nirvana!!! I always half-expected those 2 & twenty rates would decline as the behemoth state pension funds would negotiate lower fees, but they are freakin’ ‘pussies’ — u know, politically appointed (and maybe, I dunno, receiving kickbacks). Times change, though…they always do. Best for ’16…PJS
“And it did better than the hedge fund industry: it earned a measly 2.4% on its assets.”
Not necessarily. This 2.4% return was for the period June 30, 2014 thru June 30, 2015. The Wilshire 5000 returned 6.72% during this time. You’re comparing apples (calendar 2015) to oranges (6/30/14 to 6/30/15).
So here are more apples and oranges:
Hedge funds lost 3.75% through the third quarter. The big October rally pulled them out of that hole mostly. So the timing difference is now down to three months…. and a gain of 2.4% for CalPERS for the 12 months through June v a loss of 3.75% for hedge funds for 9 months through September.
And you’re too comparing apples and oranges by comparing the Wilshire 5000 to hedge fund returns….
“So hedge funds across the $2.9 trillion industry were in the red for December and ended the year 2015 down 0.85%, according to HFR’s fund-weighted composite index. ”
And unless I’m very mistaken, these numbers are likely worse in reality as there is self-reporting bias (some hedge funds close before they ever report their numbers because they are so bad, others decide to stop reporting when they fall on hard times.)
Who are the fools (???) who allow so called Fund Managers to invest on their behalf. You pay “management fees” and get joke return (if any) just to break even, calculating for inflation.
Do it on your own and if you don’t where to park your money Google best monthly, quarterly, yearly performers, see what they “manage” in portfolios and keep and reinvest cash you would otherwise pay for fees.
I do it on my own for 15 years and mostly as a momentum trader where I get 4-5% in one day or week and spend rest of the month or sometimes months in cash waiting for new opportunity.
For starters, buy only stock with large daily volume and well known companies with dividends (or not), leaders in their respected fields.
And other Hedge Funds, after bilking Billions, decide to just close shop to outside investors and manage their and their families ill begotten gains.
CalPERS may have ‘earned’ 2.4%, but we can bet their actuaries are counting on @5-8%p.a..
In the long run, without REAL economic growth, funds and insurers will be forced to bet with even more leverage. As it is “investment” is a dead letter and speculation – a polite euphemism for wagering – is the only future.
And in the longer run they are dead anyway. Gold-holders and frugal savers will be the last ones standing.
Let’s assume a 50/50 asset allocation split between stocks and bonds. At a guess I’d say most pension plans are assuming returns in the 7-8% range so let’s say 7.5%. With relatively safe bonds yielding about 3%, this implies that the equity returns needed would have to be in the neighborhood of 12%
to make their target. If not, either taxes, tolls, user fees etc. will have to rise or benefits will have to be cut. I don’t see any other way out.
Private equity is getting slaughtered as well.
With so many sectors/asset classes getting killed, I am at a bit of a loss as to how the indices are still holding up.
The honest and smart hedgies are closing while admitting that the market is RIGGED (how about that?) by the front running HFTs by mere nano-second (no doubt their brokers too).
…”admitting that the market is RIGGED..”
And from the post –
“…increased short-term market volatility..”
There’s more to it than just the HFT’s. Years ago I was tryng to initiate an opening trade into a strongly rising market on pullbacks and kept getting whipped out with the trailing stop not very close at all. Invariably the trade turned around right after my exit. Several times. You can write an algorithm for anything.
As much as the industry (and certain portions of the govt) want us to believe, “stop-hunting” is real and algos are programmed to do just that (in addition to the other shenanigans, such as spoofing, etc).