Hedge Funds Pile Into Stocks After Missing Rally

There’s a reason hedge fund managers are paid so handsomely. They are considered to be smarter than everybody else when it comes to investing. But that hasn’t been the case recently.

Last year was a terrible one for hedge fund managers, who were clobbered by market volatility. This year isn’t off to a promising start either. The U.S. stock market has been on an upward tear. Hedge funds have trailed S&P 500, however, since the rally began in October, according to Bloomberg News. ”These people have missed it again,” says Philip Orlando, chief equity strategist at Federated Investors. “They’ve been unduly bearish in their outlook. That’s certainly come back to hurt them.”

Now hedge funds are getting back into stocks. According to the International Strategy & Investment Group, the funds are still slightly bearish, but they’ve moved more aggressively into shares since the end of November.

This could mean two things:

Hedge funds have finally gotten it right. There is good reason for hedge funds to be more bullish on stocks, whether they are coming to this realization belatedly or not. This month, Fed Chairman Ben Bernanke reaffirmed his position that the economy is growing stronger. He also said the Fed would keep interests rates at record lows through late 2014 to make sure nothing changed. That has weakened the demand for U.S. Treasuries, which have lost 1.4 percent of their value so far this quarter. So where else do you put your clients’ money if you run a hedge fund—where else right now but the stock market?

The market is still confounding the hedge fund guys. Bloomberg notes that some of the best performing shares in the rally have been those of such companies as Netflix, Bank of America, and Sears. What do they have in common? They were targeted by short sellers, many of them at hedge funds. Now these pessimists have been forced to buy shares of the companies to cover their losing positions. ”Hedge funds are at least part of the underlying strength in the recent move [in the stock market], and it has to do with not only buying stocks, but first and foremost covering,” says Michael Holland, founder of Holland & Co. in New York. ”It’s been a brutal time to be on the short side.”

Either way, the industry largely missed out on a 27 percent gain in the S&P since October. If fund managers want to look smart and collect high fees, they shouldn’t do anything like that again.

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