Commentary > Bid and Ask
Hurting hedges
It's been a good year for the market, but a so-so year for hedge funds.
December 12, 2003: 8:39 AM EST
By Justin Lahart, CNN/Money Senior Writer

NEW YORK (CNN/Money) - Investors have been pushing cash into hedge funds this year like never before. But it doesn't seem like they're getting their money's worth.

Through the first three quarters of the year, hedge funds pulled in a record $45.4 billion, according to Tremont Capital Markets, nearly three times as much as they brought in for all of 2002. Yet through the end of October, the CSFB/Hedge Fund Index rose just 12 percent. Long/short equity funds were up just 12.6 percent compared with a 19.4 percent gain for the S&P 500.

In a year where many mutual fund managers are, for once, beating their benchmarks, hedge funds are lagging behind.

On the face of it, that doesn't seem so bad. Hedge funds are supposed to be "selling alpha" -- giving investors stable returns regardless of where markets go because they are able to bet on and against the market as well as use complex derivative transactions that most other investors cannot, or will not, use. As a result, on big-up years for the market, hedge funds may not go up all that much.

But that doesn't seem to be the way it's worked out this year. Instead (and anecdotally) many funds appear to have made outsized bets on various markets continuing in whatever direction they were going and then getting burned badly.

As stocks fell sharply in February and March, for instance, managers piled into short positions -- and then held onto them too long when the market bounced back.

When Treasurys rallied in May and June on the mistaken notion that the Fed would be buying them to keep rates low, many funds with very little experience piled into the bond market through leveraged positions in the iShares Lehman 20+ Bond Fund, or TLT -- an exchange-traded fund that tracks long-term bonds. Again, they got hammered.

In essence, many hedge funds are just acting like momentum investors, content to latch onto trends and, through their ability to leverage up, make outsized gains if the trend continues. This makes them far more volatile than they're really supposed to be. And it also adds a lot of volatility to markets in general.

Bid and Ask
Written by: Justin Lahart

Where's the next hedge-fund mistake going to come? Many players are loading up on commodities these days, particularly gold. The Japanese yen is another favorite. They are short duration, which means they believe long-term interest rates are going to go up more than short-term rates.

If any of these bets turn sour, it's going to be violent.  Top of page

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