Hedge fund managers have the potential to earn much larger fees than other investment managers do. The two and twenty compensation structure allows the best-performing managers to earn hundreds of millions to billions of dollars in fees when they make big profits for their clients. However, when hedge fund returns barely surpass or even lag benchmarks, such as the Standard and Poor's (S&P) 500 Index, critics attack the two and twenty structure by saying that it unfairly rewards managers.
From 2011 to 2015, average annual hedge fund returns of 1.7% lagged far behind average annual returns of 11% for the S&P 500 Index. The Barclays Hedge Fund Index, which measures the average return of all hedge funds, generated year-to-date (YTD) returns of 0.76% through the end of May 2016, compared to 2.59% for the S&P 500 Index. The rally in equities that began in early February 2016 exacerbated the disparity between hedge fund and market performance. Some observers wonder whether hedge funds might overweight equities in the second half of 2016 to catch up with equity market returns.
Hedge Funds Trail Equities
The turmoil in commodity and international markets at the beginning of 2016 led hedge funds to reduce their exposure to equities by 8.7% at the start of the second quarter, which was the largest reduction since 2011. At the same time, hedge funds increased their short positions. As the rally in stocks gained steam in the second quarter of 2016, the spread between S&P 500 Index returns and hedge fund returns grew larger. On June 6, 2016, returns on the Hedge Fund Research Index, which is another measurement of hedge fund performances, trailed returns on the S&P 500 by the widest margin at any point in 2016.
Investors Remain Sidelined
The reduction in lengthy positions and growth in brief bets left hedge funds too hedged and now not lengthy enough. Nicholas Colas, chief marketplace strategist at Convergex Group LLC, believes that hedge finances might also trade out of quick positions and reallocate assets into less crowded and doubtlessly greater worthwhile long positions. A continuation of the fairness rally inside the 2nd half of 2016 could supply hedge budget a chance to enhance their returns.
However, hedge budget aren't the best investing magnificence that neglected the rally within the 2nd quarter of 2016. Mutual finances raised coins ranges, and retail buyers were absent in the course of the rally. In truth, businesses, which repurchased $165 billion in their own shares, accounted for in reality all of the shopping for in the 2nd region of 2016.
Playing Catch-Up
The underperformance of hedge funds and mutual funds relative to the S&P 500 Index can also bode well for equities within the second half of 2016. Money managers probable sense pressure to shop for stocks as a way to carry their performance consistent with the benchmark index. At the stop of the primary region of 2016, hedge price range owned simplest five.Four% of stocks of groups inside the Russell 3000 Index. Second-zone facts may show that funds elevated their publicity to this index.
Hedge budget need to overweight their fairness holdings to trap up with benchmark indexes. Neil Azous, founder of Rareview Macro LLC, referred to that there are two methods that hedge price range could same or surpass equity marketplace returns: hedge price range ought to stay underinvested if equity markets plummet, or hedge price range may want to use leverage to outperform fairness market profits.
Big Bets on Momentum
Data from May 2016 SEC Form 13F filings shows that hedge funds are aggressively reallocating their assets into momentum stocks, which are stocks that have performed the best over recent history. Research from the Goldman Sachs Group Inc. (NYSE: GS)
)shows that hedge funds are concentrating their bets in fewer names. Hedge funds hold a greater percentage of their assets in their top 10 holdings than at any point on record. How momentum stocks perform in the rest of 2016 may determine the fate of many hedge fund managers. If hedge funds continue to underperform, it could lead to a wave of redemptions from investors. However, if hedge funds outperform, it could signal a rebirth for the industry.
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