WHEN the liquidity tide recedes, investors from sovereign wealth to billionaire family offices are getting even more impatient with hedge funds.
They are discovering that a lot of these expensive money managers don’t really hedge, and the pivot toward private equity was the right decision after all.
Hedge funds are on track for the second-worst year of return on record, beaten only by the steep losses during the 2008 Global Financial Crisis.
Star managers are nursing billion dollar losses. Tiger Global Management’s main hedge fund, which started the year with US$21bil (RM93.6bil), lost about half of its value as of July.
Melvin Capital Management, a once-high-flying manager that got an unusual bailout from Steve Cohen’s Point72 Asset Management, shut its door in May.
Much of this year’s pain was borne by the so-called long-short equity funds, by far the biggest and most popular sub-category with about US$1.2 trillion (RM5.35 trillion) assets under management.
On average, they fell about 9.9% in the first seven months, data compiled by Bloomberg show.
It’s not supposed to be this way. This environment could have been good for managers who look at company fundamentals.
According to Bernstein Research, over the last year, metrics that had stopped working for years, such as price-to-earnings or cash flow yield, became good predictors of stock performance again. Good stock pickers could have come off handsomely. So what happened?
More likely, there are just very few skilled managers out there. Many are merely leveraged long funds riding a decade-long tech wave and ultra-low rates.
Having bearish positions is only to give them room for ultra-bullish bets.
After all, hedge funds can’t charge much for long-only positions; investors can buy Cathie Wood’s ARKK Innovation ETF instead.
As of June, the average long-short ratio of an equity fundamental fund was 1.8 times, data compiled by Goldman Sachs Group Inc’s prime services show.
Hedge funds have already drastically pared back their bullish bets. A year ago, for every short positioning, there were more than twice as many long ones.
Even the recent unwind was ill-timed. As the likes of Tiger Global, Coatue Management and D1 Capital Partners rushed to reduce their net equity exposure, they missed the July rally.
A glimpse of this industry’s rise gives us some sense of how inexperienced managers can be. There have been about 14,000 hedge funds in existence, according to Bloomberg data. Most of them were launched only in the last two decades or so, when the macro conditions were fairly benign.
At only 47, Tiger Global’s Chase Coleman, for instance, is already an industry titan.
The world’s largest family offices have been steadily paring back their money allocation to hedge funds, to an average 4% versus private equity funds’ 8%, according to the latest annual UBS survey. The wealthy want to live a good life, and not stressed by big price swings.
Even the argument that private equity’s outperformance may have come from a liquidity premium is flawed. Some hedge funds, it turns out, can hold very illiquid assets.
For instance, Hong Kong-based BFAM Partners, a prominent trader in Asia’s high-yield dollar bonds space, couldn’t meet investors’ withdrawal requests in the June quarter. It had to settle with 77% in cash, and the rest paid out in shares in a “liquidating vehicle”.
These days, traders who want to sell their Chinese developer bonds are struggling to find buyers.
Granted, mark-to-market accounting rules disadvantage hedge funds. Private equity valuation has a lot of gray zone. Their asset write-downs tend to be lagged, and may not arrive at all if the next recession turns out to be as short-lived as the one in March 2020.
Nonetheless, long-term investors such as Calpers, the US$440bil (RM1.96 trillion) California public pension fund, look at investment multiples over long horizons. To them, hedge funds that manage to lose US$10bil (RM44.6bil) in six months are scary.
Private equity managers have been insatiable fund raisers, offering fee incentives to entice sovereign funds for long-term commitments and tapping into private banks for wealthy families.
As they make their capital call, it will be even harder for hedge funds to justify to their investors why they are charging so much and what their value-add is. This industry is getting slaughtered by private equity. — Bloomberg
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. The views expressed here are the writer’s own.