Hedge funds fail to protect ….again

10th October 2011

That was early September. Now, a whole month of market turmoil later, the question remains equally relevant.  For figures for last month released by Hedge Fund Research show the funds – and their "masters of the universe" managers  – have failed to protect against the big falls of the last weeks.

As the funds come with mandates which allow all sorts of strategies – going long, short, and using derivatives are among the easier to understand – the rationale for big manager earnings is that funds perform even when there is market mayhem.

The HFR figures show that the entire hedge fund universe, measured by its Weighted Composite Index fell 2.81% in September and has lost 4.74% since the start of the year.

That figure is biased towards the very large funds whose extra size carries more weight. On an average of all hedge funds basis, September feel 4.9% – the year to date figure is 8.7%.

The hedge fund world is complex – HFR has 28 different categories of funds for which it has created indices – so the September figures have wide variations. The biggest falls are in Energy and Raw Materials related funds which on average lost 9.47% in September and is 16.13% down on the year.

Emerging market equities fared little better. The Russia (in many ways, a proxy for energy and raw material but with extra political risk) and Eastern Europe index is down 9.42% on the month (14.5% this year) while Asia excluding Japan is 9.33% lower (16.13% since New Year). 

By contrast, just two sectors gained – Short Bias which takes bets on stocks falling was up 6.9% while Systemic Diversified managed to hold its head above water with a 0.2% September advance. Systemic Diversified is black box investing, defined in Macroanalyst blog as "the function of mathematical, algorithmic and technical models, with little or no influence of individuals over the portfolio positioning."

These are averages. Some funds have fared far worse. According to Reuters hedge fund legend John Paulson's  Advantage Fund is 47 per cent down this year – it lost 19.3% in September alone.  This is far worse than an equity tracker fund, following a number of bets which went disastrously wrong.

So what are investors – including pension funds and absolute return funds as well as funds of hedge funds – getting for their two-twenty fee structure?  Two-twenty is the most common set-up where investors pay 2% a year plus 20% of profits. There is no mechanism for managers to hand back 20% of losses.

As the fund performance figures are exclusive of costs (these can vary) then individual investors have done worse than the HFR figures indicate.

More from Mindful Money:

Capitulation: Are we there yet?

How Eurozone Instability affects Global Investors

Three surprising winners in the current market turmoil

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