click for larger graphic

Hat tip Bianco Research

The chart above raises a very interesting question: Why are hedge funds underperforming this year?  In general, the answer would involve costly fees, and no Alpha creation — but what is it about this year that is so problematic?

A few theories have been trotted out:

• Excess Correlation
• Lack of clear trend
• Federal Reserve Intervention

I doubt any of these are the answer — I think there are two primary possibilities:

1) Managers have been excessively timid this year. (I am not sure why given Fed guarantees of ongoing liquidity).

2) Nassim Taleb’s suggestion that the Alpha that most managers create is the result of dumb luck, and not skill.

Between those two possibilities, I am leaning towards Taleb’s explanation . . .




Friends and colleagues who run hedge funds all understand I am not referring to them.

Category: Hedge Funds, Investing

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

14 Responses to “Why Have Hedge Funds Underperformed in 2012?”

  1. tbrogs says:


    This is an interesting post, I follow the the IQ Alpha Hedge Strategy (IQHOX) and the Merrll Lynch Factor Model (MLEI or HDG)). Both of these indicies are very simialr to the HFRI. What I have found through looking at the relative performance of hedge fund performance versus the S&P50o is historically the Hedge funds underperform in a bullish rsing equity marekt environment becasue they are not 100% invested on the long side, they are typically hedged with a % on the short side at all times. Therfore, the average hedge fund index HFRI typically underperforms in rising equity market and outperforms in a declining market. So, from my observation, generally speaking, hedge funds are just that, always hedged and never fully exposed tot he market.
    I have a chart that shows this if your interested in seeing it.

    -one mans observation

  2. capitalistic says:

    I agree with both assumptions. Low volatility creates less opportunities for hedge funds. However, hedge funds focused on illiquid assets are making a killing this year.

  3. Barry,

    Great post and I always love to listen to your insights on Bloomberg Surveillance. I would vote for #1 over #2. You are correct that liquidity has been rampant but it is hard to ignore fundamentals just to throw your hat into the ring of a manipulated market. In the long run (e.g. ex-sentiment swings) how does QE boost the economy or stock market? I love this quote from John Hussman…

    “If we examine the way that QE actually operates, and how and why risk premiums have responded to prior rounds, it is entirely unclear that a further round will have much effect beyond an initial spike of enthusiasm. That is, unless one adopts a superstitious faith that stocks will rise in response to QE, since QE makes stocks rise, because QE equals stocks rising, with no further analysis needed.”

  4. ben22 says:


    maybe on the hedging within the funds, but then again, the performance graph here shows that even during the 2011 decline the managers short trades, on average, still didn’t lead to any outperformance versus the S&P Might be more informative to look at this from the year 2000 through now to see if the long/short strategy is adding value through several bull/bear cycles.

    some of this might be due to saturation in the hedge fund arena?…it seems hedge funds total assets keep growing and the number of hedge funds over the last 7 decades has kept going up steadily as well…so of course more of them won’t outperform as the numbers get larger and many don’t have strategies that add any value over time to begin with.

    anyway, here’s a thought….Taleb was out with this not long ago

    “He says many of the best money managers earn their success based on “spurious performance” and these folks “rise to the top for no reasons other than mere luck, with subsequent rationalizations, analyses, explanations and attributions.”

    my first thought was that maybe this explains Taleb himself…fairly certain he rose to fame after massive outlier bets ahead of the 87 crash….though I’m not certain about that

    my second thought was about John Paulsen…did he get very lucky with his subprime bets and he’s not done great since that time because his analysis on subprime was nothing more than a rationalization?…was “seeing” the housing crisis blind luck?

    I’m hesitant to chalk everything up to dumb luck (and yes, I see Barry says “most managers”, not all)

  5. VennData says:


    “…However, hedge funds focused on illiquid assets are making a killing this year…” Since they’re illiquid, how in the world do you know that?

  6. znmeb says:

    I haven’t looked at the numbers, but I’m guessing they’ve underperformed because … wait for it … it’s hard to beat the market. ;-)

  7. wally says:

    I like Taleb’s explanation, too.
    Having gotten lucky on pessimism and shorting, they then assumed their negative posture was eternally the smart one. It isn’t.

  8. kaleberg says:

    For a while it seemed like everyone and his son-in-law was opening a hedge fund. My guess is that any intrinsic hedge fund advantage has been arbitraged out. It’s like high speed trading and lots of other things. You can make money when no one else is making money that way, but as soon as enough people give it a try, no one makes any money.

  9. djgt123 says:

    Too much correlation in markets, so hard to get value added trade. Leads to less leverage as once a trade goes wrong more or less the whole portfolio heads the same way. And hedge funds that “hedge” don’t make a lot in this environment. Other major issue is valuation of anything in a zero interest environment across the major central banks. Only FX carry trade really is Aus dollar vs the rest and how much can a big fund squeeze into that market.

  10. [...] have hedge funds have underperformed in 2012.  (Big Picture, [...]

  11. McMike says:

    If the Fed can trade in Treasury bonds, or mortgage bonds why not in derivatives such as ETF’s? If the Government can own shares directly in GM and AIG why not buy the stocks of the S&P indirectly through ETF’s? And DIA, and QQQ too. Is the demand for S&P 500 shares coming from individual investors and/or from equity mutual fund inflows? Or perhaps from pension funds or insurance companies going “risk-on” ? Perhaps the Fed could take a shortcut this way to help under-funded pension plans, and influence the “wealth-effect” simultaneously! Why not? Perhaps the Fed does not want to be showed up by the so-called hedge fund geniuses. TIC.

  12. adbutler007 says:

    If it was absence of talent or plain old regression to mean, then we would see precisely that – the hedge fund performance numbers would converge on the benchmark. But that’s not what we see.

    Instead, we see long/short managers systematically taking the exact wrong side of almost all trends through 2011, and then becoming timid in 2012. Behaviourally, this is precisely what we would expect to see – thrice bitten, twice shy.

    The long/short trade right now essentially amounts to whether we believe the Fed has the power to manage the market higher in perpetuity, or whether there are limits to Fed driven liquid asset price inflation, especially since markets are egregiously expensive by every meaningful measure (note: TTM PE is NOT a meaningful measure for forecasting future price performance). Obviously, the hedge fund crowd’s actions suggest most believe there are limits. The fact that we haven’t seen those limits doesn’t rule out the counterfactual; it simply means our sample size is too small.

    Wait for it…but do something constructive in the meantime.

  13. cfd says:

    There are always funds and people who can beat the markets. It’s just a question of how to find them. For the average investor hedgefunds are not accessible. That’s why i use the copytrader feature with forexbroker eToro. That way I can profit from the results of the best and most succesful traders.

  14. [...] time frames, say year-to-date, make hedge funds look positively awful, yet the point here is not to pile on over the issue of hedge funds underperformance but to make [...]