The first half of 2011 has been humbling for many of the $2 trillion hedge fund industry's biggest stars, with the likes of John Paulson, David Einhorn, and Louis Bacon losing money for their investors money while underperforming the major U.S. stock market indexes.
At the year's half-way point, the average hedge fund was off 2.12 percent, preliminary data from Hedge Fund Research show. By contrast, the Standard & Poor's 500 gained 6 percent.
Only six months ago, few investors would have forecast that as of June 30, Paulson's flagship Advantage Fund would have lost 15 percent, or Einhorn's Greenlight Capital would be down 5 percent. Even Louis Bacon's flagship Moore Global fund, which has boasted average annual returns of 19 percent for more than two decades, was down 5 percent for the year through June 16.
The lackluster performances from so many top managers come at a time when the hedge fund industry is perceived to be roaring back to life following the financial crisis.
In the first quarter of 2011 alone, hedge funds took in $32 billion in new money from pension funds and other institutional investors, more than half the amount added during the entire year of 2010. Thanks to fresh demand, especially from pension funds, the industry now manages more money than it did before the beginning of the crisis during the summer of 2007.
Yet these men and other so-called smart-money traders showed themselves to be quite fallible this year when it came to navigating the fallout from events like Japan's earthquake and nuclear disaster, the uneven U.S. economic recovery, enormous volatility in commodity prices and ongoing concerns about Greece and the solvency of other European nations.
Some presumably savvy traders also have stumbled over bad bets entirely of their own making.
Paulson's $37 billion hedge fund empire has been pounded by a disastrous $500 million loss on Chinese forestry company Sino-Forest whose financial statements have been called into question by a well-known short seller.
"The glory boys have had a tough time lately," said Charles Gradante, co-founder of Hennessee Group, which invests with funds and tracks industry performance.
Poor performance is sparking worry that unless these managers turn things around soon, some of the industry's biggest names will be hit with redemption notices in the second half of the year. A wave of requests from investors to get some, if not all, of their money back could force some managers to quickly liquidate positions to return cash fast.
EYES ON PAULSON
Right now a lot of eyes are on Paulson & Co. Investors in his $18 billion flagship strategy have until the middle of August to decide whether they want to redeem some of their money by the end of the third quarter. Up until now, most Paulson investors have been loyal to the billionaire trader, given that he has earned them an average 20 percent a year in the past.
To be sure, six months is nearly an eternity on Wall Street and plenty of time for managers to post healthy gains.
Indeed William Ackman, whose Pershing Square Capital has delivered an average annual gain of 19 percent until now and is often down early in the year, was off 2.27 percent during the first first 5-1/2 months of the year.
Digging into the mid-year numbers, it appears many funds were fairing poorly thanks to one brutal month. Overall, funds were down 2.09 percent in June, marking their biggest decline this year, data from Bank of America Merrill Lynch analysts show. The bulk of hedge funds pursue an equity long/short strategy and these funds, on average, lost 3.07 percent in June, the analysts said, noting that only equity market neutral funds, as a group, posted positive returns in June.
More detailed data will be released later this week.
Even Dan Loeb, whose Third Point, has been one of the industry's top performers, took a mighty blow in June because of a big bet on gold, said one of his investors, who is prohibited to discuss performance publicly. Loeb's main fund fell 2.9 percent in June, slimming the year's gains to 6.3 percent.
Another fund trading higher this year is $2 billion Autonomy Global, a so-called global macro fund which bets on currencies and bonds and is up 4.5 percent this year.
For many managers, the hardest thing to gauge correctly this year has been the roller-coaster nature of the global economic recovery. Funds positioned to profit from an economic rebound by betting heavily on bank stocks and consumer products manufacturers were whipsawed by global events.
GREECE IS THE WORD
Yet ironically, Greece, one of the biggest financial headaches of the year, has been hard for many hedge funds to profit from. Industry experts say managers of big funds have refrained from betting against Greek sovereign debt in part because they don't want to be seen as profiting from the misery of the cash-strapped nation. Managers, already battling a reputation of acting like heartless vultures, are wary of being demonized by politicians for betting on a Greek default.
So as an alternative to betting directly on a Greek default, some funds have opted for proxy trades that include wagering against the euro currency or shorting shares of European banks with big exposure to Greek debt. Now with a potential deal to allow the Greek government more time to pay down its debts, a few funds are going "long" Greece in the hopes of catching the rebound.
One such fund is Boaz Weinstein's $3.4 billion Saba Capital Management, which has been buying long-dated Greek bonds that are selling for about 40 cents on the dollar, said a person familiar with the fund's strategy. The former Deutsche Bank bond trader is said to favor Greece's 30-year sovereign debt because it sells at a substantial discount to the nation's short-term debt notes.
A person familiar with the trade said Saba is simultaneously buying so-called recovery swaps on those Greek bonds, a derivative that effectively locks in the price a bond would fetch in the event of a default. In the case of Greece, recovery swaps on the nation's 30-year sovereign bonds are selling for about 37 cents on the dollar.
Industry analysts say most hedge funds are shying away from the kind of Greek trade that Saba Capital, up about 3.5 percent this year, is doing because of the risk.
But with six months to go in the year, it appears many top managers will have to take on quite a bit of risk if they want to end 2011 firmly in the black.
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