Hedge Funds (2012) a poor investment? Hedge funds are often pitched to prospective clients as an asset class that can beat the markets or a specific benchmark like the SP 500. However, hedge funds have been failing to deliver in recent quarters. Check out the latest DowJones Credit Suisse Hedge Fund Index. As you’ll see, every single major category of hedge fund lagged the SP 500, which climbed 5 percent in January.
Taking a look at the thumbnail chart of the past 5 year performance history of the Hedge Fund industry, what can we glean about the suitability of Hedge Fund investments and more importantly about the markets as we go forward in 2013. First, prior to the financial collapse in 2008, the Hedge Fund industry was doing fairly well. They often did as well or better than the SP 500. Secondly, they did manage risk fairly well during the financial collapse – they lost less money than the SP 500. It is one of the primary reasons they have grown. But in recent years what has happened?
Hedge Fund managers have been too focused on preserving capital as opposed to making money. This preservation of capital was the theme during the financial collapse and it served them well – but they have failed to make the transition to actually making money. They have gotten away with this, because the choices for investors were poor paying bonds. But as interest rates begin to rise, they can no longer hide behind this. They have been complacent and investors will start to demand better results. This will signal some churn in the industry as poor managers will get dumped. We are already seeing this, as some funds are facing redemptions and some investors are moving into other investments – such as non managed ETFs (Exchange Traded Funds). Hence the rise of the ETF industry.
So the Hedge Fund manager will be on the hunt for performance to keep their jobs. For the markets this means these performance chasers, could push markets farther than we expect to more irrational levels. They will need to take more risk. More risk means at some point the markets could turn more volatile. This is one reason that market dynamics change over time. This current slow grinding up market will give way to a more volatile roller coaster market. As traders we need to aware of this and we will need to adjust trading styles accordingly. The current low complacent volatility will soon change – we are already seeing this in Forex. Be on the watch out for this change soon.
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