We have frequently written about the underwhelming performance of hedge funds over the last several years and continue to be perplexed by the seemingly misinformed decisions of the largest pensions and endowments to pay ridiculous fees for consistently lackluster performance (for example, see “Why Hedge Funds Remain The Worst Performing Asset Class Of 2016“). As Bloomberg recently noted, long-short funds tracked by Credit Suisse returned negative 4.3% in 2016 compared to a positive 9.5% return for the S&P, the worst relative performance for hedgies since 2011.
Of course, nothing illustrates the idiocy of the “2 and 20” hedge fund fee structure better than Warren Buffett’s $1 million bet with a hedge fund manager in 2008, in which Buffett bet that the S&P would outperform hedge funds over a 10-year period. (see “The Traditional “2 & 20” Fee Structure Is Taking A Hit As Hedge Funds Continue To Underperform“). And, for those who like to keep score, the S&P is currently winning by well over 40%, on a cumulative basis.
So, after years of underperforming their benchmarks, hedge fund managers have apparently decided that if they can’t beat the S&P they might as well match it. As Bloomberg notes, at the end of 2016 the net exposure of long-short hedge funds tracked by Credit Suisse soared to all-time highs. That said, gross exposures barely budged which means managers simply took off shorts and added long positions to their portfolios. And while effectively buying the S&P will help dress up the relative performance of these funds, we’re not sure it’s is a strategy worthy of a “2 and 20” fee structure.
Meanwhile, as the S&P continues to soar to new highs on a daily basis, earnings trends for the past couple of years would seem to suggest that hedge funds may be dropping their shorts at precisely the wrong time.
Of course, when your lack of short exposure blows up your “hedge” fund, it’s not really a big deal because you’ll be able to point to all the other funds that did the same thing and simply raise a fresh billion dollar fund and start the game all over again.