Hedge Funds Will Have A High Failure Rate, Says Cooperman

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Last week CalPERS (California Public Employees’ Retirement System) made headlines by pulling out of hedge funds, forcing fund managers of all sizes to ask if other institutional investors will soon follow them out the door. According to Leon Cooperman of Omega Advisors, talking to Bloomberg’s Stephanie Ruhle following his talk at the Most Influential Summit, the best funds are going to be fine, but the industry’s failure rate is going to be high.

Some managers aren’t as able as they should be, says Cooperman

“Money goes where money’s treated best,” said Cooperman, explaining that it’s not just a question of whether the normal 2/20 cost structure is too much, funds also need to make sure that they share their clients’ objectives to keep the relationship on track. He sets out his objectives, for example, as having no down years, beating the S&P net of fees, and keeping volatility below market levels. Other hedge funds may have different objectives but whatever they are, managers who fail to meet them ‘should expect to be terminated,’ says Cooperman.

At the same time, talented managers looking at either 1% performance fees working for a typical mutual fund or 2/20 at a hedge fund are obviously going to be attracted to the latter, along with some of their not-so-talented colleagues.

“[The pay] has attracted a lot of people who probably aren’t as able as they should be,” says Cooperman. “Everybody knows how to swing a golf club, but some people do it better than others. Of the ten or eleven thousand hedge funds there will be a high failure rate.”

We’re in a stock pickers’ market, says Cooperman

As for the market itself, Cooperman doesn’t think everyone appreciates that the combination of low interest rates and moderate profit growth means that stocks are going to have a lower rate of return than they have in the past, and last year’s incredible bull market hasn’t helped to keep expectations in check. That doesn’t mean we’re in a bubble, but stock pickers have the advantage over those relying on beta.

“Volatility in the market strikes me as being too low given all the geopolitical hotspots around the world,” says Cooperman. “I do think it’s a stock pickers’ market… the market is not priced to perfection, but it’s reasonably fully valued.”

Cooperman says that he’s lagging the S&P 500 this year, and highlights the SandRidge Energy Inc. (NYSE:SD) and Monitise Plc (LON:MONI) (OTCMKTS:MONIF) as two underperformers that he thinks are seriously mispriced by the market. He estimates that SandRidge has about $10 per share in assets, in line with the current CEO’s numbers but more than double the stock’s current price, and think that Monitise is tapping into an enormous new market.

“It’s probably the most rapidly growing area of the economy in terms of demand,” says Cooperman. “The customer wants it because they don’t want to go to a bank branch they want to do their banking on their phone. The bank would like it because it’s cheaper to service a customer on a smartphone than it is to service the customer in a branch. So there’s no question about the growth in demand, the question really is do they have a better mousetrap than somebody else?”

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