Hedge Funds Are Not Imploding

November 23, 2015

The performance of the S&P 500 is on a par with real ten-year Treasury rates yet, many financial reporters prefer to focus on hedge fund performance, going so far as to suggest they are imploding which, by definition, means a sudden and complete failure.

While it is true that not every hedge fund develops and pursues a successful strategy, to suggest hedge funds are imploding is blatant hyperbole—not news!

The strength of the hedge fund industry lies in its ability to innovate. Hedge funds are the vast experimental laboratory of financial innovation.  Some of these experiments are wildly successful … others are dismal failures and, most fall somewhere between these extremes.

Do the Critics Have It Right?

Hedge fund returns have been unimpressive.  In fact hedge fund returns, in the aggregate, are at the lowest levels since the financial crisis. Although this could turn on a dime, it isn’t likely that hedge funds, on average, will have a stellar 2015 in the gains department.

Yet, Goldman Sachs has plans to invest $1.3 billion in hedge funds via minority stakes across a broad spectrum of select firms. Has Goldman Sachs lost its collective mind? Of course not! This is the second iteration of the Petershill Fund which Goldman Sachs deployed in 2007. Regardless of your views on Goldman Sachs, everyone can agree that it would not revisit this strategy had the first venture not been successful.

What hedge fund critics so frequently fail to acknowledge is that wealth creation is not a hedge fund’s primary goal. The first duty of a hedge fund is to preserve wealth. Hedge funds were never intended to be the vehicle of choice for the investor seeking to build a retirement fund, a nest-egg for that dream vacation or for the nice young couple saving for their first home. On the contrary, hedge funds were conceived to protect wealth previously created and yes, grow it to the extent possible in a risk-averse paradigm.

Capital Preservation and Growth

Capital preservation is not typically compatible with growth. The rule of the thumb for investors has always been, the greater the risk, the greater the reward. This is the dilemma faced by every hedge fund manager and, for that matter, every investor.

Like heart surgeons, some hedge fund managers exhibit more skill than others. When choosing a doctor to perform a quadruple bypass, it pays to look into the track record, educational background and reputation of the surgeon. Similar due diligence is required when choosing a hedge fund.

It is no more appropriate to trash the whole medical profession when a bypass surgery goes awry than it is acceptable to disparage the entire hedge fund industry when a hedge fund fails to meet expectations. In the end, it is all about risk management.

Institutional investors, pension fund managers and high net worth individuals turn to hedge funds first for risk mitigation, and second for potential gains. If gains were the prime objective, we would not see them invested in hedge funds.



Bill Gross has spent the past several months beating the drum for a rate hike. His reasons for taking this position are fairly obvious. Mr. Gross is in the bond market. Many of those favoring the status quo also have ulterior motives, so please understand…this is no condemnation of Mr. Gross’ position on the subject of a rate hike. Excellent arguments can be made on both sides.

Bill Gross’ Rate Hike Argument

In Bill Gross’ recent Bloomberg Radio interview with Tom Keene and Michael McKee, Gross spells out his reasons for being 100% certain that the FOMC will vote to raise rates at the December meeting.

Gross cites the following two points as the basis for his position:

#1) October non-farm payroll employment increased by 271,000

#2) Wages increased more than at any time in the past 6 years

If It Was Only That Simple

While these two points are irrefutable, their significance to the FOMC and its Chair, Janet Yellen, is open to debate. The FOMC is charged with holding inflation in check and ensuring labor market durability.

The Bureau of Labor Statistics (BLS) report states unequivocally, the number of unemployed persons remains essentially unchanged in October and unemployment rates in major worker groups also remains static. One month’s results are not indicative of a trend and are not suggestive of any certainty with regard to labor market durability.

By Mr. Gross’ logic, the FOMC would have implemented a rate increase in December 2014, when the BLS report revealed that November 2014 non-farm payroll increased by more than 400,000. Despite this robust job growth, no rate increase materialized.

Similarly, Mr. Gross’ point regarding the leap in wage increases, fails to comprehend the 5% decline in wages that occurred in the aftermath of the financial crisis. The month-over-month increase amounts to 0.6 percent and, the average of September and October is a paltry 0.4 percent. This two month average is actually lower that the 0.5 percent increase wages saw in August 2015. In short, the BLS report provides no definitive evidence that wages are experiencing sharp upward momentum.

Digging Deeper

The November 2015 BLS report reveals other substantive reasons for the FOMC to refrain from a rate increase in December. For example, the labor force participation rate was unchanged in October and, has remained at current levels for most of 2015. The most telling detail of the report is an acknowledgement that the manufacturing, wholesale trade, transportation and warehousing, information, and financial industries showed little or no change in month-over-month employment numbers and, the mining industry actually lost 5000 jobs.

The Most Compelling Argument Against a Rate Hike

How will Janet Yellen and the FOMC explain a rate hike to 65 million social security recipients who have been denied a cost of living increase because the government has determined that the inflation rate is zero? Incidentally, 2016 marks the third time the Obama administration has announced a freeze on the cost of living increase to social security beneficiaries.

A rate hike, widely viewed as a mechanism to cool an overheated economy, is hardly defensible in view of the virtually flat Consumer Price Index the administration cites as its reason for denying recipients an increase.

For the FOMC to implement a rate hike on the heels of the administration’s denial of a cost of living increase is like cancelling Christmas because the Pope is coming to visit.


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