Hedge Funds Throw In The Towel (At Exactly The Wrong Time)

If you feel like this market is making your life miserable with its violent moves up and down, don’t feel too terribly bad because you are certainly not alone. It’s tough out there this year and according to reports, SEC filings and exchange data, the so-called smart money hedge fund managers haven’t exactly nailed this market.

According the Hedge Fund Research, hedge funds managers are having their second worst year on record, second only to 2008, which saw the collapse of Lehman Brothers. The Chicago-based research firm says that the average hedge fund manager is down -4.4% as of the end of November, with many big names experiencing double-digit declines.

It also appears that many hedge fund managers opted to throw in the towel on 2011 at exactly the wrong time.

To be sure, 2011 will go down as one of the most difficult trading environments in many years. While stock indices have trended beautifully on a big-picture basis since 2000, this year’s massive moves – all of which occur in a very short period of time – have made life quite difficult for even the fast-money types.

According to Bank of America’s Merrill Lynch, hedge funds cut their exposure to stocks to the lowest level since 2008 during the last two months.

A report from analyst Mary Ann Bartel , entitled “Hold ‘em and Fold ‘em,” says that hedge funds have responded to this year’s extreme market volatility by cutting their exposure to the stock market risk by more than one-third. And the timing of this move wasn't exactly spot on.

“The very analysis that hedge funds rely on has become secondary to the headlines coming out of Europe on a daily basis,” said Michael Murphy, CEO of hedge fund Rosecliff Capital. And it appears that funds have cut exposure right before the impressive rebound began.

Stocks began falling at the end of the summer, pulverized by unemployment figures and a brutal debt ceiling debate at home, as well as the ever-expanding sovereign debt crisis in Europe.

Record high correlations also appear to be at least part of the problem as the traders shun stock analysis and instead focus on the “risk on/risk off” trade. “The uncertainty coming from the Eurozone has created an environment where almost all asset classes have traded in tandem and fundamental analysis has been almost irrelevant,” Murphy added.

“The rally in October was a worst case scenario,” Murphy mentioned, referring to the big move up based on the much ballyhooed European “grand solution” bailout plan. “It brought the S&P back to the black for 2011. A lot of funds were extremely hedged or new short due to the global uncertainty.”

Political uncertainty both here in the U.S and in Europe has been a primary cause for the up-one-minute, down-the-next environment. For example, although optimism is building that EU leaders have finally found the right mix of ideas, the terms of the European bailout have yet to be defined as of this writing. Further, the failure of Democrats and Republicans in the U.S. to agree on any policy specifics to cut the U.S. deficit almost ensures political peril will spill over into next year.

It seems hedge funds have grown exhausted by the nonstop market volatility according to Bank of America Merrill Lynch analysis of SEC disclosures, along with NYSE and Nasdaq data.

According to Barry Bausano, Deutsche Bank’s head of equities for the Americas, the volatility is clearly wreaking havoc with even the fast-money managers. “The market has traveled the distance between 1,100 and 1,200 seven times, and that volatility doesn’t always lend itself to completely rational decision-making,” Bausano told the FT.

The end result of the year’s roller coaster ride has been a lot of red ink – even in the hedge fund industry. As of November 30, the HFRX Global Hedge Fund Index compiled by industry observer Hedge Fund Research is down -9.9% for the year and the S&P 500 remains modestly negative, even in light of the late-month, furious rally. And on a global basis, most foreign markets are also in the same boat.

“Volatility plus correlation equals no liquidity,” Alec Levine, an equity derivatives strategist with Newedge Group SA said. Levine opines that we are ushering in a new economic era: “…Welcome to the ‘live to fight another day’ market.” As the saying goes, he who fights and runs away, lives to fight another day – or in this case, manage money for another year.

 

 

 

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