Wary investors move away from hedge funds

The slow decline of the hedge fund market has been one of the more dramatic stories of the last decade, with nearly no end in sight for its woes: The first quarter of 2016 saw a loss of $15 billion in assets, with investors moving away from the industry due to high fees and low returns.

“We are in the first innings of a washout in hedge funds,” Daniel S. Loeb, the founder of the hedge fund Third Point, wrote to investors in a recent letter. Typifying the poor performance of the industry is the recent $26 billion sale of LinkedIn to tech giant Microsoft. As Forbes’ Nathan Vardi points out, hedge funds were almost entirely absent from the list of LinkedIn’s biggest shareholders, meaning that they missed out on benefiting from what could have been an incredibly lucrative sale and subsequent stock price surge – with the big winners being mutual funds and other institutional money managers.

“Recent years has left hedge funds struggling to find backers.”

This failure to recognize an major opportunity – LinkedIn stock had seen several price fluctuations in the last year, rising as high as $269 before sinking to $98.25 a few months later – embodies the issues that many investors have with the hedge fund market as a whole. This has led to several dramatic shifts in the power dynamics between managers and investors, as well as innovations in the approach of managers to locating the best possible investments.

Shift in power
While hedge funds historically were able to be selective in who they took on as investors, recent years has left them struggling to find backers as big-names like MetLife, American International Group and the New York City pension plan have withdrawn their investments.

“We had a very negative experience in hedge funds,” Peter D. Hancock, the chief executive of A.I.G., told investors earlier this year. This has led to the group promising to pull its $11 billion in hedge fund holdings.

By shaking up the control held by hedge funds, a more democratic approach has emerged, according to the New York Times, where hedge fund managers are more willing to negotiate with investors and offer lower fees and better terms in return for locking in the investment over the long-term.

“Managers are having to negotiate, and investors are demanding much more than they used to in the absence of value,” Adam I. Taback, head of global alternative investments at Wells Fargo Investment Institute, told the New York Times. “High fees are like an expensive car. It is fine as long as you’re getting performance out of it.”

“At the root of hedge funds woes has been ‘wrong-footed bets.'”

A crowded market, a ‘herd mentality’
At the root of hedge funds woes has been poor economic progress, a shaky stock market and what the New York Times refers to as “wrong-footed bets” on macroeconomic trends. The Times points out that hedge funds, in the desperate pursuit of a sure thing, often engage in a “herd mentality,” not recognizing (or worse, actively ignoring) the regulatory or credit risks associated with an investment.

A grim example of this was Valeant Pharmaceuticals International, a topic 2015 pick of many hedge funds with a stock price high at nearly $260 a share. Heavily favored by hedge funds, news of a government investigation and a suspect pricing strategy effectively hobbled the company and funds lost billions.

Waiting on a sunny day?
The one silver lining seems to be an increased openness to alternative investments by hedge fund managers. An example of this is Cumulus, a small niche hedge fund that tracks weather derivatives and finds arbitrage opportunities. Since it’s launch in 2006, it has shown impressive gains of over 65 percent nearly every year, in spite of having no correlation to the S&P 500 index or the S&P GS Commodity index.

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