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Daniel Loeb’s Third Point fell around 20 per cent in the first half of the year, having lost money on stocks including software firm SentinelOne and electric-vehicle maker Rivian Automotive, according to investor documents.Steve Marcus/Reuters

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Hedge funds are heading for one of their worst years of performance on record, leaving investors frustrated with how many managers have failed to offset sharp falls in equity and bond markets.

Funds were down 5.6 per cent on average in the first six months of 2022, according to Chicago-based Hedge Fund Research Inc. (HFR).

While a narrower HFR daily index of performance shows them clawing back around 0.5 per cent last month, the industry is nevertheless on track for its second-worst year of returns since 1990, when the data provider’s records began – beaten only by steep losses during the 2008 global financial crisis.

Much of the pain has been concentrated in so-called long-short equity funds, which manage around US$1.2-trillion in assets and bet on rising and falling stock prices.

They dropped 12 per cent on average in the first half of the year, according to HFR. The group was expected to have gained only around 1 per cent in July, according to an estimate by JPMorgan Chase & Co. head of positioning intelligence John Schlegel, a much shallower rebound than the 7 per cent rally last month for global equities.

“Clearly, in long-short equity, it’s been a complete disaster,” says Scott Wilson, chief investment officer of the endowment fund at the Washington University in St Louis, Mo., adding that some funds had given up years of gains in this year’s sell-off.

He says it had been a “rough year” for funds that had bet on the fast-growing companies that were in vogue at the height of the pandemic but have pulled back sharply in 2022.

Among the funds suffering is “Tiger cub” Lee Ainslie’s Maverick Capital, which made double-digit gains in each of the past three years but was down 35 per cent in the first six months of the year. Fellow Tiger cub Glen Kacher’s Light Street Capital Management LLC was down more than 40 per cent.

Daniel Loeb’s Third Point LLC fell around 20 per cent in the first half of the year, having lost money on stocks including software firm SentinelOne Inc. S-N and electric-vehicle maker Rivian Automotive Inc. RIVN-Q, according to investor documents. And Skye Global Management, set up by former Third Point analyst Jamie Sterne, fell more than 35 per cent in the first half of the year after losing 10.4 per cent in June, according to numbers sent to investors.

In a note to clients, seen by the Financial Times, Mr. Sterne said the fund’s strong run of performance over almost six years “was emphatically broken [in the second quarter of 2022] with extremely poor performance.” The fund, which is still up an annualized 30 per cent since launch, was hit by a large position in Amazon.com Inc. AMZN-Q. Amazon had been down 36 per cent in the year to June, but has since cut its losses to about 19 per cent.

Not all funds have suffered. Some hedge fund managers’ trading, such as Brevan Howard, moves in government bonds and currencies, oil traders like Pierre Andurand and quant funds betting on market trends have made big gains this year. That has helped buoy the US$4-trillion industry’s average returns, which are well ahead of equity markets.

Nevertheless, the performance of many other funds marks a disappointment for investors who had harboured high hopes that, after years of lacklustre returns over the past decade, rising interest rates and choppier markets could allow managers to prove their worth. Sparkling performance in 2020 appeared to signal a return to a golden age of trading.

Instead, funds lagged well behind the market last year, and have in the case of many long-short funds looked ill-equipped to deal with Wall Street’s S&P 500 falling 13 per cent, including dividends, in 2022 so far.

“Some funds should have dropped the term ‘hedge’ a long time ago,” says Andrew Beer, managing member at U.S. investment firm Dynamic Beta Investments.

Long-short funds are “not what you want to have in this market,” says Patrick Ghali, managing partner at Sussex Partners UK Ltd., which advises clients on hedge funds, adding that he prefers strategies that provide more diversification.

There are already signs that the losses are deterring investors, many of whom were already wary of hedge funds. Having received a net US$13.92-billion of inflows last year, hedge funds attracted just US$440-million in the first quarter of this year, including a large outflow in March, according to data group eVestment.

And data from fund administrator Citco Group Ltd. show that funds suffered more than US$10.1-billion of outflows in June, with redemptions of US$7.8-billion expected for the third quarter and US$6.4-billion for the end of the year.

Washington University’s Mr. Wilson decided several years ago to cut his fund’s allocation to hedge funds from about 20 per cent of the portfolio, and has now reduced it to around 5 per cent.

He says that there is a “portfolio construction problem” with these funds. First, holding a basket of hedge funds can leave an investor effectively owning a huge number of long and short equity positions that can resemble the market, meaning that they would be better served simply by owning cheaper index trackers. Second, if one hedge fund makes money and a second fund loses a similar amount, the investor still ends up paying the first fund manager a performance fee.

Other investors are also taking action. Dutch pension fund Stichting Pensioenfonds ABP has been reducing its exposure to hedge funds and assessing which strategies it can carry out in-house, rather than allocating to an external manager, as a way of reducing costs and improving control.

However, the weak performance doesn’t appear to have dented the industry’s confidence in its ability to attract investors.

A survey of 100 hedge funds managing US$194-billion by technology firm SigTech found that 23 per cent expected a dramatic increase in institutional investors’ allocations to hedge funds over the next two years and a further 60 per cent expecting a slight increase. Only 4 per cent expected investor allocations to fall.

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