Dumb Money: Hedge Funds Can't Even Beat Bond Funds

They are supposed to be the smart money—the best of the best—yet they can’t even beat a basic Treasury bond fund.

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Hedge fundsas a group are badly underperforming this year, which could lead to a series of redemptions, closings and rethinking of the lofty fee structures the managers of these alternative vehicles enjoy.

The Bank of America Merrill Lynch global diversified hedge fund composite index returned just 1.3 percent in the first half of 2012, well below the S&P 500’s 8.3 percent gain.

Funds that focus on betting against stocks performed the worst, falling 7.1 percent as a group, according to the report.

Perhaps even worse than their underperformance of the S&P 500 was that the group trailed the iShares Barclays Treasury Bond ETF, which is up almost six percent on the year.


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“If you’re a fundamental stock picker, good luck earning your 2 and 20 in this environment,” said Gina Sanchez, director of equity and asset allocation strategy for Roubini Global Economics. “Macro risk hasn’t been this high since the Asian crisis.”

It seems that yet another global credit crisis—this time inEurope—is causing the kind of herd behavior that makes it hard for hedge funds to identify stocks and other securities that will deliver return above and beyond that of the market.

Goldman Sachs noted in a report to clients—many of them hedge funds—that correlations among individual stocks have increased significantly since March, meaning they move in lockstep with one another. Goldman expects expect that to continue, making it even harder for hedge funds to reverse this trend in the second half.

“We continue to expect a slow recovery in the stock-picking environment as macro growth concerns and event risks dominate the investment environment,” wrote Goldman’s Stuart Kaiser, in a note.

Funds from notable hedge fund managers such asJohn Paulson, Daniel Loeb and David Einhorn underperformed the market in the first half.

Einhorn, in an interview with CNBC, implied that the Federal Reserve’s policy of zero interest rates is making it difficult for everybody.

“I think it is actually counterproductive having very low zero rates,” said the manager of Greenlight Capital. “It is sort of just depressing to people. I think it deprives savers of reasonable incomes and the ability to forecast.”

It also pushes investors out the risk curve into alternative investments like hedge funds, a losing proposition so far this year.

“This shows that investors need a mixed basket of investments, some fixed income, some long stock and some alternative investments,” said Brian Stutland of Stutland Volatility Group.

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