Why Hedge Funds Tripped in a Volatile Year

Many of the hedge-fund managers who came into 2011 riding a wave of momentum ended the year scratching their heads and nursing losses, whipsawed by markets that seemed to punish them month after month.

Take billionaire hedge-fund titan John Paulson, arguably the industry’s biggest star and one of the wealthiest people in the world after making billions of dollars in 2007 with bearish bets on subprime mortgages.

Mr. Paulson began 2011 on a high note, having personally scored more than $5 billion in profits in 2010, and was poised to make more money on big bets on gold and a speedy economic recovery. But by the end of 2011, not only had Mr. Paulson’s home on the Upper East Side in Manhattan been a target of Wall Street protesters, but the investing guru also saw his trades backfire, causing one of his biggest funds to lose about half of its value.

The rise and fall of Mr. Paulson and his firm, Paulson & Co., offers a window into what was a frustrating year for many hedge-fund managers, including some of the industry’s most-storied.

In 2011, hedge funds on average lost 5%, according to an estimate by Hedge Fund Research Inc., lagging behind the Standard & Poor’s 500-stock index, which gained 2.1% on a total-return basis. The net result was that hedge-fund performance, for the third straight year, lagged behind stock-market returns.

The culprit behind the disappointing numbers, many people in the industry say, were the wild market swings, especially in stocks. The economic crisis in Europe fueled the uncertainty, and was often amplified by domestic events, such as S&P’s downgrade of the U.S.’s triple-A credit rating.

As the uncertainty caused stock markets to plummet in August and September, many managers raced to take down their investments, causing many to miss out on October’s comeback, one of the best months for stocks in decades. Nervous managers, already bitten by months ofvolatility, saw markets move sideways for much of November and December.

Full article-http://online.wsj.com/article/SB10001424052970203391104577125511459240368.html?mod=googlenews_wsj

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