Going through my daily abnormal returns browse these days makes me want to misquote Admiral Beatty at the Battle of Jutland: there seems to be something wrong with our bloody hedge funds. They’re crapping out left and right. What gets me is not just that they are all doing it at the same time, which is astonishing enough, it is that it seems to be getting worse. Given half decent risk management, this should not be happening. I was aware of the existence of hedge fund beta where it comes to Quants, but I had always assumed there was sufficient diversity of opinion within the rest of the popular hedge fund strategies, particularly in equity long short, so that they would have some sort of diversity in their returns. I had also assumed that these guys were smart and flexible enough to be able to stop themselves out, to switch stuff around and refashion their portfolios to find something that works. At the very least, they could have just stopped doing anything, cover shorts, sell longs, and go flat.
This is clearly not the case, and I have not yet found a convincing explanation for it. The Citadels, Atticus(-ses, Attici?), Tontines, Fortresses of this world seem to be deer in headlights. Their performance is deteriorating over the course of this year, not stabilising. September was the worst month ever, we were told, so it would not be a very difficult decision to retrench, take some action, gross down and change orientation some way. Instead we find out that October was worse.
What the hell is going on? Is it just that they are deeply stupid? Like the Janus and Nicholas Applegate long only guys in 2000-2002, holding on to Worldcom and JDS Uniphase until they were carried out? Is it that they are still leveraged? Is it because other strategies are losing much more money than the equity long short guys can be making or not losing? Is it because they are stuck with illiquid positions they can’t exit, or have to slowly and their own selling pressure is bleeding them white? Are they just structurally net long? How and why? Why can’t they change??
I suspect there are 2 main explanations. Firstly, while these big multi-strat managers may not actually be stupid, their problem is more that they are hidebound, cowardly and unimaginative. They are locked in a terrfied protective huddle in the same old positions, that makes them nothing more than a vast target. Secondly, they have squeezed everyone out of the market. Small hedge funds don’t get a look in. Long short equity hedge management as it is currently run is a vast crowded trade, and losses in the weight of money devoted to it outweighs the gains of the very few who are coining it. They can’t bet against the system like the old ones did; they are the system. Continue reading