Hedge Funds Continue To Struggle But Some Strategies Endure

With Goldman Sachs Group Inc.’s announcement to shutter one of the biggest and best performing funds in the world due to sizeable portfolio losses this year, managers and investors are buzzing about what the most effective strategies are in this volatile and unpredictable market.

As we have reported several times this year, even some the hedge fund industry’s biggest names are having trouble competing. And just last week Goldman Sachs announced that it will be closing its Global Alpha fund, which was once the envy of the hedge fund industry.

“For whatever reason, Global Alpha just couldn’t compete in the very market- high frequency, quantitative trading it helped invent,” a person close to the situation told Reuters. “It couldn’t keep top people on board anymore because it didn’t have the assets to make the compensation attractive.”

By early September of this year, Global Alpha had tumbled 13%. Furthermore, the retirement of Katinka Domotorffy, current chief of the once revered fund, has led eyebrows and questions to raise about Goldman’s ability to manage quantitative strategies.

Some speculate that the company’s decision to liquidate indicates a more noteworthy verdict to exit quantitative hedge fund strategies entirely.

However, Goldman assured investors that the rumors are unfounded.

Global Alpha’s strategy has been to utilize complex algorithms to detect trading opportunities.

Yet for all hedge funds, the primary aim is to reduce volatility and risk, simultaneously attempting to preserve capital and deliver positive returns no matter market conditions.

With multiple strategies employed by different firms and managers, each offers varying degrees of risk and return.

“Hedge funds are supposed to provide real diversification- a source of return that’s presumably not related to other asset classes,” Mark Spitznagel, CIO of Universa Investment said.

His firm operates a niche strategy, focusing on what is called “tail risk.” In short, Spitznagel and his colleagues buy and sell options that benefit only when a rare, large market event takes place.

Interestingly, recent inflows indicate a newfound (or re-found) support for the approach. Thus far this year, hedge funds in this group have raised more than $16 billion, nearly double last year’s figure.

Strategic trends at this time are leaning toward four traditional hedge fund categories including: Equity Hedge, Relative Value, Global Macro and Event Driven.

According to an industry researcher at Morningstar, “Global macro has replaced Equity Hedge as the darling of the industry… [as the funds] have attracted more than $20 billion… [and serve as] the only strategy that has received inflows of capital every year since 2007.” However, Equity Hedge is on the road to recovery following massive outflows in 2008 and 2009. Managers explained the rockiness as a result of the trouble finding overvalued stocks when 1,500 other managers are in the market for the same inefficiencies.

Relative Value funds have been most successful in 2011, returning 3.2 percent year-to-date. This approach attempts to exploit price differences between varying securities.

While Event Driven strategies are typically successful for corporate activity, 2011 has been bleak for this particular tactic, losing nearly $4.5 billion. Mangers suggest that patience is necessary for this strategy to result in positive returns.

Spitnagel stated his preference for niches with “clear competitive advantages.”

Though his methods may seem unpredictable and risky, with people both creatively and somewhat desperately attempting to play the market to their advantage- anything seems possible.

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