Much of the pain this year has been borne by so-called long-short equity funds, by far the largest and most popular sub-category with around $1.2 trillion in assets under management. On average, they fell about 9.9% in the first seven months, according to data compiled by Bloomberg.
It’s not supposed to be like this. This environment could have been good for managers looking at business fundamentals. According to Bernstein Research, over the past year, measures that had stopped working for years, such as the price-earnings ratio or cash flow yield, have once again become strong predictors of stock performance. Good stock pickers could have done just fine. So what happened?
More likely, there are very few qualified managers. Many are just leveraged long funds riding a decade-long tech wave and ultra-low rates. Having bearish positions only serves to give them room for ultra-bullish bets. After all, hedge funds can’t charge much for long positions alone; investors can purchase Cathie Wood’s ARKK Innovation ETF instead.
In June, the average long-to-short ratio of a fundamental equity fund was 1.8 times, according to data compiled by premier services at Goldman Sachs Group Inc. Hedge funds have already cut their bullish bets significantly . A year ago, for every short position, there were more than twice as many long positions.
Even the recent outcome was inopportune. As Tiger Global, Coatue Management and D1 Capital Partners rushed to reduce their net equity exposure, they missed out on July’s rally.
An overview of the rise of this industry gives us an idea of the inexperience of managers. There are about 14,000 hedge funds, according to data from Bloomberg. Most of them were only started in the last couple of decades or so, when macroeconomic conditions were rather benign. At just 47 years old, Chase Coleman of Tiger Global, for example, is already an industry titan.
According to UBS’s latest annual survey, the world’s largest family offices have steadily reduced their allocation of money to hedge funds, to 4% on average compared to 8% for private equity funds. The rich want to live a good life and not be stressed by large price fluctuations.
Even the argument that private equity outperformance could come from a liquidity premium is flawed. It turns out that some hedge funds can hold very illiquid assets. For example, Hong Kong-based BFAM Partners, a leading trader in Asian high-yield dollar bonds, was unable to accommodate withdrawal requests from investors during the June quarter. He had to settle with 77% in cash and the rest paid in shares in a “liquidation vehicle”. These days, traders looking to sell their Chinese Developer Bonds are struggling to find buyers.
Admittedly, mark-to-market accounting rules put hedge funds at a disadvantage. Private equity valuation has many gray areas. Their asset write-downs tend to be lagged and may not happen at all if the next recession turns out to be as short as March 2020.
Nonetheless, long-term investors such as Calpers, California’s $440 billion public pension fund, are eyeing investment multiples over long horizons. For them, hedge funds that manage to lose $10 billion in six months are scary.
Private equity managers have been insatiable fundraisers, offering incentive bonuses to attract sovereign wealth funds for long-term commitments and tapping into private banks for wealthy families. As they raise their capital, it will be even more difficult for hedge funds to justify to their investors why they charge so much and what their added value is. This industry is being slaughtered by private equity.
More from Bloomberg Opinion:
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• Rajeev Misra must do something right: Ren and Trivedi
• When Crypto’s Own Hedge Fund Geniuses Failed: Lionel Laurent
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She holds the CFA charter.
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