The great hedge fund humbling of 2011: Excuses, excuses and more excuses


Some of the best-known hedge fund managers have offered lots of excuses for underperforming the major stock market indexes last year, with many large funds posting double-digit losses.

In letters to investors, managers pointed to things like Europe’s debt crisis, a slower-than-expected economic recovery in the United States, and unforeseen events like Japan’s nuclear disaster all coming together to create a tricky trading environment that was characterized by big and often unpredictable swings in stock prices.

The result was a humbling year for the $1.7 trillion (1.1 trillion pounds) hedge fund industry, with the average fund dropping 4.8 percent and some stock-focused funds suffering an average 19 percent decline, according to research compiled by Hedge Fund Research and Bank of America Merrill Lynch analysts.

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Investors who sidestepped hedge funds and instead chose mutual funds fared much better. For example, the Vanguard 500 Index fund gained 2 percent, and PIMCO’s StocksPLUS Long Duration Fund, 2011’s best performing mutual fund, enjoyed a 21.2 percent return.

Not everyone is buying the hedge fund managers’ excuses. These skeptics are saying that no matter how smart the managers may be, they are prone to make mistakes just like everyone else and are not necessarily blessed with perpetual special insight into markets.

Industry observers say what tripped up many famous managers in 2011 was that far too many traders were piling into the same large stocks.

“Investors anoint a new hedge fund demi-god all the time,” said professor Jim Liew, who teaches hedge fund strategies at New York University’s Stern School of Business. “But they are bound to be disappointed because the rule of thumb is that a manager who can be up 40 percent one year can be down 40 percent the next. They are absolutely human.”

One example is Whitney Tilson. His $250 million T2 Partners LLC has generally outperformed the major stock market indexes, but last year was a far different story, with his main fund tumbling 25 percent after losing big on stocks like Iridium (IRDM.O) and Netflix (NFLX.O).

“It has been an extremely frustrating — and humbling — experience,” Tilson wrote in a recent letter to investor.

Some in the hedge fund industry say investors should exercise caution before throwing in the towel on managers who lost big in 2011. Industry analysts say that over the long haul, hedge funds have outperformed the major indexes, and last year may simply have been one of those rare times that trip up even the smartest and savviest traders.

After all, hedge funds, unlike most mutual funds, can bet that stock prices will fall by shorting a security, something that has helped them earn eye-popping returns in the past.

“I’m not saying hedge funds did everything perfectly, but it is hard to fight the type of headwinds these managers are facing,” said Francis Frecentese, who oversees hedge fund investments for Citigroup’s (C.N) private bank.

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