Stocktake: Hedge funds prove to be a suckers’ bet

Hedge funds prove to be a suckers' bet Ray Dalio of Bridgewater Associates has replaced George Soros as the all-time top-earning hedge fund manager, according to London-based LCH Investments, which releases a yearly table of the 20 most profitable hedge fund managers. Focusing on the top 20 is all very well, but what about everyone else? How have they performed?

Badly. The top 20 earned $15 billion last year; the rest of the industry lost $99 billion. Since the industry's inception, hedge funds have generated $835 billion in profits, with almost half that amount coming from the top 20 managers. "All but 20 hedge funds are for suckers" might be an appropriate headline, suggested money manager Barry Ritholtz.

LCH Investments, which invests in hedge funds, took a different tack, saying the big guns’ “staggeringly good” returns over the last decade showed “it is possible to make significant profits for investors, even in the most challenging of conditions”. However, the reality is precious few hedge funds outperform, and picking the big winners in advance is like looking for a needle in a haystack.

Additionally, even fewer maintain their outperformance. John Paulson famously netted $15 billion after betting against subprime in 2007 but has endured some disastrous years since then. Bill Ackman fell out of the top 20 list due to bad bets over the last year that resulted in his fund losing a fifth of its value.

Ritholtz is right: betting on hedge funds is a suckers' bet. Soros not at 'war' with China George Soros is also attracting headlines in China, where authorities are not pleased with his recent warnings of a Chinese hard landing.

State news agency Xinhua, which recently warned of “legal consequences” for those engaged in “reckless speculations and vicious shorting”, said Soros “will pay a painful price for shorting China”. The People’s Daily was also in aggressive mood, saying Soros’s “war . . . cannot possibly succeed”.

What war? Ironically, Soros has not actually recommended shorting Chinese stocks or its currency. Over-the-top condemnations invariably arise when authorities are feeling the heat. During the Asian financial crisis in 1997, Malaysia’s prime minister called Soros a “moron”; Greece’s response to soaring bond yields in 2010 was to blame “unprincipled speculators”, while Spain warned of “an international conspiracy” to “destroy” the euro; and, in 2013, Turkey’s prime minister promised to “throttle” and “choke” so-called speculators.

This nonsense always gets trotted out in times of stress. China's prickly response indicates a nervousness that will hardly assuage the doubters. Oil and stocks in lockstep Something rare happened last Wednesday: for the first time since December 3rd, noted Bespoke Investment Group, the S&P 500 dropped more than 1 per cent while oil was up more than 1 per cent.

These days, when oil falls, so do stocks (even airline stocks); when oil rises, stocks follow suit. With correlations hitting unprecedented levels, investors could be forgiven for forgetting that lower oil prices have traditionally been viewed as positive for stocks.

The current environment makes sense if demand for oil is collapsing as a result of global economic weakness, but not everyone is convinced. Deutsche Bank recently noted other asset classes are also being driven by oil prices rather than by fundamentals, adding that this was "puzzling" seasoned market observers. It suspects, as do some other strategists, that the lockstep moves are being driven by algorithms and by traders trading on correlations.

Either way, the current correlation between oil and stock markets is atypical, to say the least. The two assets will eventually decouple; the question is when. The return of volatility Stocks have taken a pummelling in 2016, but bulls have also enjoyed some fast and furious rallies.

Further rallies are a given, but investors should resist the temptation to see each move higher as indicative of a market bottom.

There was little or no volatility, as measured by the Vix index, between mid-2012 and late 2015. Ill-informed commentators habitually cited the market calm as evidence of 2007-style complacency, the proverbial calm before the storm.

In truth, low-volatility regimes can last for years, and are generally good for stocks. In 1995, for example, the S&P 500 enjoyed only nine one-day gains of more than 1 per cent. Nevertheless, the index kept creeping higher, eventually gaining 34 per cent that year.

Big rallies may provide temporary reassurance, but it’s worth remembering they are more a feature of bearish markets than bullish markets.