History is replete with examples of politicians, nations, industries, athletes and professionals of all stripes who have shot themselves in the foot. Gary Johnson, the current Libertarian presidential candidate, is a recent example from the political camp.
The hedge fund industry is also the victim of self-inflicted wounds. Every headline such as this one, Hedge Fund Manager Used Terminally Ill Patients for Profit: SEC, or, this one, Hedge Fund Managers and Former Government Official Charged in $32 Million Insider Trading Scheme, damages the reputation of the hedge fund industry in much the same way rogue cops damage the image of the law enforcement profession. In enterprises of this size and scope, the occasional bad actor is inevitable. Problematic as these bad actors may be for the hedge fund industry’s image, they are not the proximate cause of its current woes.
The Culprit Is Performance
It is no coincidence that assets under management have slipped in the wake of back-to-back years of under-performance. While hedge fund management and performance fees have long been fodder for the media, those who invest in hedge funds have been reluctant but willing participants in those fee structures.
Rather, hedge fund net outflows are a direct result of performance and, not surprisingly, are largely traceable to hedge funds that have a solid track record of under-performance.
Aggregate hedge fund gains have fallen far short of investor expectations. In 2015, aggregate hedge fund returns were an under-whelming 1.97 percent. Through the first 6 months of 2016, returns fell short of that low bar, with aggregate gains of 1.09 percent.
Hedge Funds Must Help Investors Make Better Choices
Looking at hedge fund returns in the aggregate is a disservice to potential investors. Hedge funds pursue a variety of strategies and their managers possess varying degrees of competence. Significant numbers of hedge funds are achieving outsize gains, in many cases, doubling, tripling or even quadrupling the gains of the industry aggregate.
A hedge fund is not a franchise. Unlike McDonald’s, where the hamburger at one tastes exactly like the hamburger at another, and by the way, for the same price, hedge funds are snowflakes —no two are alike.
Of course, investors know this, but hedge fund firms frequently do a poor job of marketing those attributes which set their firms apart from the aggregate. In part, this is the fault of government regulation, which serves as a strong disincentive to marketing. While it is true that the solicitation ban was lifted, a corresponding plethora of new rules was promulgated to govern the manner in which marketing efforts can be pursued.
The Trend Is a Positive One
As market volatility declines, hedge fund gains have risen. Returns have trended in a positive direction through the first half of this year. Hedge funds can accelerate this turnaround by differentiating themselves from their competition and assuming a proactive role in educating would-be investors. This is not a new concept. As early as January 2008, the Alternative Investment Management Association made similar proposals as an outgrowth of the President’s Working Group on Financial Markets, which was formed in 1988 by President Reagan.
In time, the wounds that the hedge fund industry has endured, will heal.