The performance of hedge funds remained strongly coordinated with the S&P 500 (INDEX.INX), despite its under-performance, according to Mary Ann Bartels, analyst at Bank of America Corp (NYSE:BAC) Merrill Lynch.

hedge funds correlation with S&P 500 BAML research

The one-year correlation of hedge funds with S&P 500 (INDEX.INX) is still high, at 82 percent in September 2012, compared with the historical average of 30 percent. Last year, the one-year correlation of hedge funds with the S&P 500 reached as high as 98 percent.

Bartels said, “The drop in correlation comes with a staggering underperformance relative to the S&P 500. The question remains: are there too many hedge funds chasing too few returns?”

Based on the latest BofAML Hedge Fund Monitor, in September hedge funds increased by 51 percent, while the S&P 500 climbed by 2.42 percent in September. Long/short equity funds posted the best performance last month, with a 0.96 percent growth. Event driven funds rose by 0.85 percent, while short biased funds declined by 1.34 percent.

According to Bartels, the figure showed that market neutral funds bought market exposure to 4 percent net long, from 1 percent net short. The market exposure of equity long/short funds surged from 19 percent to 22 percent net long.

Macros sold the S&P 500 (INDEX.INX), commodities, and emerging market exposures, and bought the NASDAQ 100, EAFE exposures, and 10-year Treasuries, while partially covering their US dollar shorts.

Based on data from the Commodity Futures Trading Commission, large equities speculators purchased S&P 500, but sold Russell 2000 and NASDAQ 100 futures. Speculators in agriculture sold corn, wheat, and soybeans; metals speculators purchased gold, silver, platinum, and remained flat on palladium; while energy speculators bought heating oil, but remained flat on crude, natural gas, and gasoline.

Interest rate speculators sold 2-year and 10-year Treasuries, but bought 30-year Treasuries. Meanwhile, Forex speculators added the U.S. dollar and euro in their shorts, and sold the Japanese yen.

In a related report, a study from Infovest 21 found the average allocation of 26 public pension funds that allocated approximately $1 billion to hedge funds was 7.4 percent of their total assets in FY2012.

The figure showed that pension funds allocations in their total assets increased from 6.5 percent during the past four years since 2009, while their allocations declined from 46.9 percent to 41.3 percent. The pension funds’ allocation to fixed income also decreased from 25.9 percent in FY 2009 to 21.8 percent in FY2012.

In a previous report, New Jersey State Senator Shirley Turner introduced a bill, prohibiting state pension and annuity funds from investing in any hedge fund or derivatives contracts. Pension funds are “woefully, severely underfunded because we haven’t made regular deposits for 15 years,” according to the Sen. Turner.

She emphasized that it is wrong for pension funds to “to make up for those skipped payments by gambling on an aggressive, high-risk investment strategy.”

Sen. Turner added, “It is high-risk, high-reward, but so far the hedge funds the state has invested in have not returned the 8.2% that they had anticipated—this past year they’ve only returned 2.9%.”

Furthermore, she pointed out that pension funds cannot gamble with retirees’ money, and their investments in hedge funds should stop because it is dangerous.