Failing To Hedge – Again

Last Updated: 16 April 2024

A difficult month for hedge funds raises the question of whom these funds serve – apart from their managers.

According to Financial News, the average hedge fund (as measured by the HFRX index) lost 2.7% during the month of May, the worst monthly drop for the hedge fund industry as a whole since November 2008, immediately following Lehman’s collapse.

A Reuters report on the same subject reveals that some of the best-known hedge fund managers – Bacon, Moore, Paulson – were caught out by the markets’ performance last month, when we saw sharp equity falls, rising volatility, soaring bonds and gold, and sharp rises in the yen and US dollar against the euro and commodity-based currencies.

We’ll have to wait a few more days for details of the month’s performance to emerge, as hedge funds do not have to report their performance and much of the data has to be collected from a variety of sources. But it seems unlikely that the headline narrative will change.

The ETF incarnations of hedge fund portfolios tell pretty much the same story. db x-trackers’ hedge fund index ETF lost 3.2% during May, while the MW Tops global alpha fund fell 1.9%, leaving the fund down 1.5% since its 1 March inception and well adrift of its target of returning 8-10%, net of fees, per annum, with 3-5% volatility.

True, focussing on a single quarter’s or month’s performance would be unfair. Anyone can get market calls wrong over a span of months. But it is surely not coincidence that the hedge fund performance blip coincided with May’s sharp equity market declines, precisely the type of event that these funds are supposed to protect against. After all, exactly the same thing happened in late 2008, when it turned out that the performance of hedge funds was far more correlated to equity market trends than the funds’ marketers consistently claim.

And, giving factual support to such an assertion, James Montier of asset manager GMO recently demonstrated that intra-hedge fund correlations have risen steadily over the last 20 years, suggesting that to a large extent these managers are copying each other in the same way more traditional firms are alleged to. And they are not just copying each other, but giving investors a long-momentum/short-volatility portfolio, which is precisely what you don’t want if a long uptrend in equity markets starts to break down.

Correlation between hedge fund strategy returns

Source: GMO, Hedge Fund Research

You can achieve exactly this kind of exposure – if you want it – by combining ETFs that charge a few basis points in annual fees. So why would anyone pay 1.5-2.0% in annual fees, plus performance fees that can amount to several percent more, to buy a portfolio of hedge funds?

  • Luke Handt

    Luke Handt is a seasoned cryptocurrency investor and advisor with over 7 years of experience in the blockchain and digital asset space. His passion for crypto began while studying computer science and economics at Stanford University in the early 2010s.

    Since 2016, Luke has been an active cryptocurrency trader, strategically investing in major coins as well as up-and-coming altcoins. He is knowledgeable about advanced crypto trading strategies, market analysis, and the nuances of blockchain protocols.

    In addition to managing his own crypto portfolio, Luke shares his expertise with others as a crypto writer and analyst for leading finance publications. He enjoys educating retail traders about digital assets and is a sought-after voice at fintech conferences worldwide.

    When he's not glued to price charts or researching promising new projects, Luke enjoys surfing, travel, and fine wine. He currently resides in Newport Beach, California where he continues to follow crypto markets closely and connect with other industry leaders.

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