Hedge funds continue to count the cash

Tue, Jul 1, 2014, 01:08

Mystifyingly, investors and pension funds continue to respond to hedge fund underperformance by throwing money at the industry, with assets under management now exceeding $3 trillion for the first time ever, according to eVestment.

Last year, hedge funds returned 7.4 per cent after fees, compared to the S&P 500’s 32 per cent return. This was no isolated failing – they have underperformed in each of the last five years.

Managers protest that outperformance is not their aim, that they can deliver better risk-adjusted returns.

However, risk-averse investors may be better off with an old-fashioned portfolio made up of 60 per cent stocks and 40 per cent bonds – the 60/40 model has beaten hedge funds every year since 2002.

Hedge fund fees have dropped in recent years.

The old 2 and 20 model (2 per cent annual management fees and 20 per cent of profits) is now reportedly closer to 1.4 and 17.

Still, that remains remarkably generous, given the days of superior performance are long, long gone. Waiting for Russia It is undignified to brag, but this columnist notes Russia’s Micex index is up some 20 per cent since collapsing in early March, when Stock Take said contrarians “must be tempted by an index that looks oversold, undervalued and almost universally shunned”.

Then, US quant firm Acadian Asset Management judged Russia to be the least attractive of 23 emerging equity markets.

Now, Russia is top of its list, the $70 billion firm telling Bloomberg last week it is now “a lot more comfortable” as risk has “greatly receded” since March, a view shared by BCS Financial Group.

“The time is right to invest in Russia”, it says. “The worst in the Ukraine crisis is over”.

Thing is, that’s already priced into stocks, with the Micex now trading at pre-crisis levels. The moral?

The time to invest is not when one feels “comfortable” or when risk seems to have “greatly receded” – by then, the equity train has already left the station. Highs a cause for concern? Scarcely a week passes without US indices hitting new all-time highs. Does this suggest animal spirits? Should investors be spooked?

No. The financial media, S&P Capital IQ’s Sam Stovall said last week, “make it sound as if we should enjoy these days while they last”, but new highs “are typical in a maturing bull market”.

The S&P 500 took out its 2007 high in March 2013, and has set 67 new highs since then. In other words, since the bull market began in March 2009, all-time highs have been recorded about 5 per cent of the time.

Historically, the average bull has spent roughly 7 per cent of its time at new highs, indicating the current advance has “many more new highs ahead of it before finally running out of steam”, Stovall said.

One caveat. During secular bull markets, such as between 1982 and 2000, markets spent about 9 per cent of the time at all-time highs.

It is different during cyclical bull markets than secular bear markets (think of the 2003-07 bull market, a cyclical advance in a decade-long bear market) – then, new highs are recorded on just 4 per cent of occasions.

New highs are not a warning signal, but the data gives ammunition to both bulls and bears.

Ramadan respite in Dubai? Stocks in Dubai plunged nearly 7 per cent last Tuesday and have lost almost a quarter of their value over the last two months, following a rip-roaring bull market over the last year.

Perhaps the Muslim holy month of Ramadan, which began last Saturday, can provide some respite.

One study, Piety and Profits, looked at stock returns during Ramadan in 14 Muslim countries over the 1989-2007 period and found returns were almost nine times higher and less volatile than the rest of the year.

Ramadan likely boosts investor psychology, the researchers found, “as it promotes feelings of solidarity and social identity among Muslims worldwide, leading to optimistic beliefs that extend to investment decisions”.

Markets sleepwalking higher It’s boring out there.

The S&P 500 has gone more than 50 days since moving 1 per cent in a single day – the longest streak since 1995 – and for traders, the situation is getting worse.

On one day last week, the S&P 500 moved just 0.3 per cent from its high point to its low point, the third-lowest one-day range of the last 20 years. Its two-day trading range was the lowest since 1994.

There’s an old adage that says bull markets climb a wall of worry. As Wall Street Journal columnist Jason Zweig noted recently, however, this one “has been sleepwalking up a wall of boredom”.

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