Hedge funds posted their sixth consecutive month of gains in August, beating world equities and pushing back on arguments that their fees do not justify performance as their returns slumped over the past year.
The HFRI Fund Weighted Composite Index rose 0.4% for the month, beating the 0.12% gain for the S&P 500, Hedge Fund Research reported. Year to date, the HFRI index rose 3.5%, still lagging the 5.67% return of the S&P 500. Funds benefited primarily from lower market volatility, a resurgence in energy and basic materials stocks, and activist strategies.
Event-driven funds posted the strongest gains, with the HFRI Event-Driven Index – which includes activist and distressed strategies – up 1.8% for the month, bringing total year-to-date return to 6.0%.
“Specialized strategies across Event Driven and Equity Hedge, including Energy-focused, Distressed and Shareholder Activist posted strong gains to lead hedge fund performance in August as Oil surged while global equities, interest rates and high yield credit were essentially unchanged for the month,” said Kenneth J. Heinz, president of HFR.
“In an environment dominated by demands for ultraliquidity, a common performance theme is each of these leading strategies captures a liquidity premium over an intermediate timeframe by leveraging both fundamental and transactional specializations. Sophisticated investors and institutions which are able to assume these risks are likely to continue generating strong performance through 2H16.”
Hedge fund returns dropped for the second consecutive year in 2015, losing 1.12% net of fees, after suffering six down months. The high fees the funds charge, which eat away at the ever-scantier investor returns they produce, prompted Warren Buffett (Trades, Portfolio) to reiterate his skepticism of the industry at his annual Berkshire Hathaway (BRK.A)(BRK.B) shareholder meeting in May. Buffett said investors would do better to put their money in a low-cost index fund mimicking the S&P 500.
“Supposedly sophisticated people, generally richer people, hire consultants. And no consultant in the world is going to tell you, ‘Just buy an S&P index fund and sit for the next 50 years,’" he said. “You don’t get to be a consultant that way, and you certainly don’t get an annual fee that way.”
The fees hedge funds charge for their services – popularly known as “two and twenty” because they take 2% of total asset value and 20% of any profits – have been in decline on average since 2007, according to research firm Eurekahedge. From 2007 through 2015, performance fees dropped from 18.76% to 14.53%, while management fees declined from 1.67% to 1.43%. The lower fees have two primary drivers: funds trying to undercut each other to compete for limited investor capital in an increasingly crowded industry, and new funds started by established firms boosting their appeal further with lower fees.
Six-month winning streak and slightly lower fees notwithstanding, hedge funds would still have a long way to go to catch up to a broad index of American businesses. Over the past five years, the HFRI Fund Weighted Composite Index generated an annualized gain of 3.46%, compared to the S&P 500’s annualized return of 15.28% for the same period, as the index enjoyed the benefit of steadily low federal interest rates.
Last year also reversed the fortunes of some of the most prominent hedge funds. On the Barron’s list of 100 best hedge funds, the obscure Parametrica Global Master Ltd., which has just $476 million in assets, rose to the top of the list from 59th place in 2014. Smaller funds also tended to perform well, with only one of the top ten managing more than a billion dollars.
Noticeably absent from the list were two mainstays, Bill Ackman (Trades, Portfolio)’s Pershing Square and David Einhorn (Trades, Portfolio)’s Greenlight Capital. Ackman, in his worst year for performance, was weighed down by losing bets on drugmaker Valeant Pharmaceuticals (VRX, Financial), Platform Specialty Products (PAH, Financial) and each of his holdings except three, leading to a loss of 20.5% net of fees. Einhorn also suffered primarily with missteps on CONSOL Energy (CNX, Financial) and Micron Technology (MU), two of the 10 worst-performing stocks of the S&P 500. His short positions in Netflix (NFLX, Financial) and Amazon (AMZN), the two best-performing S&P 500 stocks, also crippled the fund, which ended the year down 20.2% net of fees.
Both funds have begun climbing out of their holes this year. Ackman gained 5.8% net of fees in August, brining his year-to-date loss to 14.3%. Einhorn reported a 2.5% gain in August, placing him up 3.4% for the year.
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