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Hedge Funds

Hedge Funds Continue to Be for Suckers

Once again, hedge funds are struggling to justify the enormous fees they charge.

Hedge funds overall were up around 6 percent as of the end of September, according to a recent report by Goldman Sachs (GS), which tracks the performance of 783 different funds. Under normal circumstances, that might not be so bad, but it comes during a year when stock market indices have mostly shot upwards, with the S&P 500 index having gained over 25 percent. As is always the case when the market is strong, hedge funds—which charge institutions and high-net-worth investors fees of around 2 percent of assets and 20 percent or more of profits—look terrible by comparison.

As Bloomberg Businessweek reported back in July, the golden age of hedge funds has largely passed. Of a handful of top fund managers called to represent their industry before Congress in 2008, almost all have left or dramatically shrunk their businesses: George Soros, considered the greatest trader of his generation, announced in 2011 that he was converting his fund into a family office and returning investor money; James Simons of Renaissance Technologies stepped away from managing investor money in 2010; Philip Falcone, founder of Harbinger Capital, went through a severe humbling at the hands of the U.S. Securities and Exchange Commission, which barred him from the industry for two years; Ken Griffin of Citadel scaled back his ambitious expansion plans; and John Paulson of Paulson & Co. continues struggling to rebuild his reputation after having sustained difficult losses.

Meanwhile, one of the most successful hedge funds of all time, Steven Cohen’s SAC Capital, is in the process of converting into a family office that manages only Cohen’s own multibillion-dollar fortune after pleading guilty to securities fraud. One of the firm’s employees, portfolio manager Michael Steinberg, is currently on trial for insider trading. (He has pleaded not guilty.)

Hedge funds were conceived as vehicles for market diversification, by which fund managers could short stocks—i.e. bet that they would fall in price—in order to “hedge” the long positions in their portfolios. During a heady up-market, shorting tends to be excruciatingly painful.

What the Goldman Sachs report also reveals is that hedge funds are mostly long, and they are mostly long the kinds of well-known stocks that your grandmother might decide to buy after logging on to her Etrade (ETFC) account: AIG (AIG), Apple (AAPL), Google (GOOG), General Motors (GM), and Citigroup (C). Which means that they are as dependent as every other investor on market support from the Federal Reserve. And which means that incoming Fed Chairman Janet Yellen may have more to say about their fate than any of the billionaires running them.

Kolhatkar is a features editor and national correspondent for Bloomberg Businessweek. Follow her on Twitter @Sheelahk.

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