Goldman Analysis Suggests Tough Row to Hoe for Hedge Funders

Hedge funds have been trailing the S&P for the better part of a year, that much is obvious. But the degree to which hedge funds have struggled hasn’t been fully documented as most aren’t obliged to share their financials. In a research note sent out to clients and obtained by eFinancialCareers, Goldman Sachs provides some more transparency. It paints a rough picture for hedge funds and their employees.

With the market roaring back in 2013, the average hedge fund generated a return of just 4% year-to-date as of Aug. 9, according to the research, which analyzed the positions of 708 hedge funds. During the same period, the S&P 500 booked a total return of 20%, meaning it outperformed the average hedge fund five times over.

A whopping 25% of hedge funds studied by Goldman posted absolute losses through early August. What’s more, a measly 5% of funds outpaced the S&P during the period.

Performance isn’t the only issue. High incentive and management fees charged by hedge funds are exacerbating the problem. Families with $200 million or more in assets allocate roughly 18% of their investible income in hedge funds, according to a recent analysis by financial blogger Phil DeMuth. Due to their reliance on hedge funds – along with private equity firms that charge equally high fees – the ultra-rich earned an average return of 10% last year. Take that same capital and invest it in similar exchange-traded funds, the same investors would have earned an 11.7% return, says DeMuth. An investor with $200 million to play with would have lost $3.2 last year in lost returns and management fees.

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Hedge funds with great track records of double-digit returns can and will get away with lofty management fees, but when you can’t beat the S&P – and in fact get slaughtered by it – it’s a tougher sell. The fallout is well underway, at least from an institutional perspective. The world’s biggest pension and sovereign wealth funds have already begun reducing their reliance on the hedge fund industry and are pushing for more independence.

In a recent gathering known as the Institutional Investors Roundtable, more than two dozen sovereign wealth fund and pension systems got together to discuss the idea of pulling money from hedge funds and private equity firms and managing more investments on their own, according to the New York Times. Investors large and small are becoming irritated with lofty fees and underperforming funds. The changing landscape likely has those employed at hedge funds on the edge of their seat.

“Unless their fund has been hitting their benchmarks over the last few years, how could they not be nervous?” said Evan Lerman, principle at IJC Partners, a Wall Street search firm. The average hedge fund employee often suffers along with a PM’s bad calls. No new capital and asset redemptions mean lower bonuses, cost-cutting and layoffs, he said. Hedge funds have been shuttering at a near record pace, even before the last six months of poor performances.

Veteran stock picker Jeffrey Vinik recently closed his firm following a period of poor performance. Roc Capital Management just liquidated its main fund for the same reason. SAC shuttered its Parameter Capital trading unit, a move that was said to be unrelated to the federal insider trading probe. Other well-known closures include Grant Capital Partners, Weintraub Capital Management and Kleinheinz Capital Partners, among others.

However, Kyle Ramkissoon, Lerman’s partner at IJC Partners, says there are still strategies within hedge that are growing, noting that the 708 hedge funds explored by Goldman represent just 10% of the industry. MLP strategies and even macro funds are having success, often booking double digit returns. Clients in these areas have been calling Ramkissoon looking for good resumes, he said.

Lerman’s advice to those in the hedge fund industry: watch your fund’s performance like a hawk, and if you’re looking to move, do it when your fund’s near its high watermark, no matter if you are a PM, fundamental trader or analyst.

Changing career paths all together is a possibility, though it’s no easy task. Quant traders with strong math skills can make a nice transition into technology, Lerman said. Fundamental guys, well they may want to look into carpentry or plumbing, he said with a laugh.