Clients shell out hefty fees—usually 2% of assets annually, on top of 20% of profits—to hedge fund managers for their skill at identifying good and bad companies, trusting that the manager’s expertise will protect them against market declines. But that expertise has waned, contends an article in Bloomberg. And with equity hedge funds down 15% so far in 2022, it’s an inconvenient time to not have a skillful manager to rely on.
Disillusioned investors yanked $25 billion out of long-short equity funds in August, and net withdrawals have topped $100 billion over the last 5 years—so much so that they’re in danger of losing their top billing to multi-strategy funds, which invest client’s money across many different asset classes and generally aren’t run by elite managers. The gap between the two strategies is now about $27 billion, compared to $235 billion from only a year ago. But the toppling of long-short equity hedge funds has long been coming, the article maintains. The last 10 years was a period of low interest rates and high share prices, and many managers simply fell out of the practice of hedging. Portfolios that were heavily weighted towards growth and tech, and light on shorts, have borne most of the brunt in the current market, losing money for investors who handed over 20% of their profits to managers who simply played it easy by going long on tech stocks.
But even shorting stocks hasn’t panned out for most stockpickers over the last decade, as low interest rates helped keep struggling companies afloat and made it easy for companies to borrow money for stock buybacks. That kept stock prices high, and managers didn’t do a great job at differentiating the top companies from the bottom. In fact, over the last several years, managers’ long picks actually did worse than their shorts, according to data from Goldman Sachs Group cited by Bloomberg. In 2022, stocks favored by hedge funds are down 31%, and their shorts have only dropped 20%. Put simply, “hedge funds are losing more on the stocks they thought would go up than they’re making back on the ones they thought would go down,” the article reiterates.
Aside from the long bull market, which diminished the pool of talent, other culprits for the disappearance of the elite hedge fund manager include the increased scrutiny that short sellers have come under from U.S. regulators, as well as the surge of retail investors working through commission-free brokerage accounts. And the field of long-short hedge funds has been oversaturated, making traders compete for the same opportunities. However, with interest rates rising, hedge funds may come back around, and many large multi-strategy investment firms still utilize equity-investing skills in house. Managers who focus their attention on niche sectors or keep a balance of long and short positions so their funds aren’t tied so closely to indexes are still doing well, such as the $24.4 billion Eureka fund out of Marshall Wace, which reported a 4.2% gain through the end of September.
But over half of those that reported numbers to Bloomberg said they’d lost at least 10% this year. Though there have been about 140 new long-short equity hedge funds launched this year, that pales in comparison to the more than 550 funds that launched every year over the past decade. Raising capital for single-manager funds has become more difficult, and some managers have thrown in the towel, such as Sean Gambino of Heron Bay Capital; he shut down his hedge fund and folded into the multi-strategy firm Eisler Capital in September. Tiger Global is down 52%, D1 Capital Partners has declined 28%, Pelham Capital has dropped 32.5%, and Lone Pine Capital has slumped 42%, and Citron Research discontinued its short-selling analysis service after 20 years. Still, the shrinking field isn’t necessarily a bad thing; Edoardo Rulli of UBS Group AG’s Hedge Fund Solutions department predicted an industry reset, where only the stronger players will be left standing.