The author of this commentary argues that the hedge fund sector is due for a strong comeback with a compelling set of opportunities lying ahead.
This news service regularly reports on how well or poorly so-called alternative investment areas perform, such as private equity and hedge funds. Hedge funds, a sector holding more than $3 trillion in assets, have been through tough times. The 10-year bull run in equities after the 2008-09 financial crash, fuelled by massive central bank money printing, meant that traditional long-only investors could capture robust returns for a fraction of what it costs to run a hedge fund. However, the spike in volatility during 2020 as the pandemic hit, and big disclocations to asset prices, created rich opportunities for certain types of strategy. Some recent performance figures from Hedge Fund Research, for example, showed the sector logging a strong 2020.
With all this is mind, Andrew Beer, founder and managing partner of Dynamic Beta investments, discusses the terrain. DBi is a New York-based asset manager that specialises in hedge fund replication. DBi manages more than $427 million of replication-based hedge fund strategies across equity long/short, multi-strategy and managed futures. DBi also manages a variety of fund structures, including the OYSTER SICAV, two US-based ETFs, a Dublin-based UCITS fund, and a Cayman Islands hedge fund built for Japanese investors. The editors are pleased to share these views and invite responses. The usual editorial disclaimers apply. Email email@example.com and firstname.lastname@example.org
Pundits love to beat up on hedge funds these days. The glory days are long gone, they argue, and investors should stick to low cost, passive investments like the S&P 500. For nearly every fund that proved its mettle during March 2020, another two imploded.
A further criticism I myself subscribed to is that hedge fund fees mean that investors are in a heads-you-win-tails-I-lose trap. With so many criticisms being levelled at hedge funds, one might think that rational investors would skip the space altogether. And yet, recent surveys show institutional investors planning to increase allocations.
The golden years
These blanket critiques miss the larger picture. During the 2000s, while the S&P 500 lost 1 per cent per annum – the “lost decade” – hedge funds returned 6 per cent a year. The shining periods were 2000-02, when hedge funds made money during the dotcom bear market by investing in cheap small-cap stocks and shorting high-flying technology shares.
Within a few years, many of those same hedge funds had pivoted into emerging market stocks and capitalised on the BRIC and commodity wave. 2007 was a banner year, as bets against subprime mortgages paid off. By contrast, 2008 was a bit of a disappointment. Hedge funds declined more than expected, some suspended redemptions and the industry was tainted by Madoff. But by the end of the decade, hedge funds had recovered.
For these reasons, the 2000s are often called the Golden Years. The 2010s, by contrast, were dominated by passive investing. In a world of constant monetary easing, a simple portfolio of stocks and bonds returned nearly 7 per cent per annum. Global investors flocked to US large capitalisation stocks, exemplified by the S&P 500 and later technology monopolists; prices rose accordingly.
This was a brutal decade for active management overall. Under-loved value stocks suffered historic underperformance and many strategies were hammered by a market seemingly divorced from fundamentals. During this decade, hedge funds returned only 4 per cent – interestingly, about 3.5 per cent above the risk-free rate.