Financial markets were severely jolted last year as the sovereign credit ratings of Japan, the US and many European nations slipped.
However, at the close of trading on the last day of the year, the Standard & Poor’s 500 index by chance stood at 1,257 points — exactly the same as at the end of 2010. With the stock market back to where it had started a year earlier, many fund managers found that they had worked hard all year for nothing.
The worst performers of all were hedge funds, whose purpose is to secure absolute returns. Sixty percent of hedge funds ended in the red, making last year the second-worst year for hedge funds in 20 years. Only in 2008 did they fare worse.
Bloomberg’s main hedge fund index showed a drop of 9 percent for the year. Although the loss was less than 10 percent, the performance of the hedge fund index was 15 percent worse than that of the Dow Jones Industrial Average, which gained 5.5 percent over the year.
Not only did hedge funds fail to deliver absolute returns, they also performed worse than index-tracking funds. That made last year a really bad year for the world’s big financial “crocodiles.”
Superstar fund managers have been losing their auras. John Paulson, who did well in the 2007-2008 financial crisis, has taken a big tumble, with his Advantage Fund last year dropping 36 percent and his Advantage Plus fund plunging 52 percent.
After becoming a billionaire by short-selling subprime mortgages in 2007, Paulson made a high-profile entry into the gold market. However, while the price of gold, in US dollar terms, rose by a little more than 10 percent last year, his gold fund fell by more than 10 percent.
Investor George Soros, who amassed massive wealth by speculating against the British pound and laid waste to the currencies of Southeast Asian countries, is also facing losses. In the middle of last year he wrote a letter to his shareholders announcing the end of his 40 years in the business of hedge fund management. He returned funds to external investors and told them that he would no longer be managing assets on their behalf.
His explanation was that he did this in response to recently announced financial regulations, and to avoid having to register with the US Securities and Exchange Commission and accept regular financial auditing, in line with the new rules. However, it is also an open secret that his company’s funds have not been performing very well in the past few years.
Interest rates around the world remain low, so the cost of raising capital is close to zero. Against such a backdrop, hedge funds have been performing worse than the stock market as a whole.
Is this the quiet before the storm, or is it because hedge funds have pulled out of arbitrage trading?
In the past, financial derivatives, including credit default swaps, made lots of money for hedge funds. However, the profits from these complex transactions have fallen in the wake of deleveraging and a decrease in proprietary trading.
Hedge funds are no longer able to provide better returns than the stock market as a whole and are no longer producing absolute returns. As a result, investment could return to its most basic form, with more funds flowing back into conventional stock market investment.
Investors can be expected to shift their attention back to the potential of companies that focus on technology, pharmaceuticals and the development of new energy sources.