RIP Equity Hedge Funds

RIP Equity Hedge Funds

over 3 years ago2 mins

After two high-profile hedge funds shut their long-short equity funds, investors are wondering if this is the end for the world’s oldest and most popular hedge fund strategy.

What does this mean?

Long-short equity hedge funds buy stocks that are expected to go up, and short – that is, bet against – stocks that are expected to go down. The resulting portfolio is supposed to be less risky than the overall market (in theory at least). So while these funds might not perform as well as the market when it’s rising, they’re expected to at least not go down as much when markets are falling.

That’s because their ability to short stocks means they should be able to protect investors’ money during downturns, and that’s one of the reasons why investors are attracted to long-short equity hedge funds in the first place. But that’s where these hedge funds have failed over the past decade: not only haven’t they kept up with rising markets, they’ve performed a lot worse than the market during downturns.

Equity hedge funds have underperformed every single year over the past decade (Source: Bloomberg)
Equity hedge funds have underperformed every single year over the past decade (Source: Bloomberg)

Why should I care?

Long-short equity funds control almost a third of the $3 trillion hedge fund industry, and so their future is crucial for the wider industry. But after a decade of poor performance, investors are starting to pull their money and funds are closing shop.

The reasons behind the funds’ poor performance highlight how tough it’s become for stock pickers to make money in this environment. First, despite a horrible climate for companies as a result of coronavirus, their share prices are still holding up. If a pandemic wreaking havoc on the global economy can’t make short-sellers any money, then what can? (So the argument goes at least.)

Second, central banks around the world are slashing interest rates and buying up massive amounts of bonds, both of which combined act as a big tailwind for all stocks. That reduces the performance disparity between different stocks and makes a long-short equity fund’s job nearly impossible. After all, these funds do best when the stocks they’re “long” outperform those they’re “short” and do poorly when a rising tide lifts all stocks…

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