The bull market in stocks recently celebrated its eighth birthday. But the current upswing in share prices is already quite old by historical market standards. Although bull markets usually do not die of old age alone, nobody knows for sure for how much longer this one will survive. But whether its death comes tomorrow or in several years, the performance so far is impressive.
This applies in particular to the U.S. stock market. The S&P 500 Index has risen 254 percent since March 2009. Beside this, we are currently witnessing the second longest run without a 10 percent correction on a monthly basis. “A true secular bull market continues to unfold,” says Mensur Pocinci, head of technical analysis at Credit Suisse.
Active strategies continue to lag
Normally, the interim result is reason enough to celebrate, but not all market participants are in the party mood. Rather, many speak of the most hated bull market of all times. The latter can be explained by the many crises in recent years, which helped to keep the mood of many market participants in check.
But that is not why the average hedge fund investor is probably not as satisfied with the past eight years as investors who just put their money in an S&P 500 Index-ETF. Their sour disposition can simply be explained by the fact that they were left behind like other leaders of the last decade, such as gold, emerging market equities and commodities.
Using Pocinci’s performance data as a benchmark, they have, in fact, every reason to be sour. According to him, the Hedge Fund Research Index (HFRI) achieved on a global basis since March 9, 2009, a total return of just 2.5 percent per year. The yearly average gains of the HFRI Equity Hedge and of the HFRI Macro were even worse, with 2.3 percent and 1.5 percent, respectively. That means they could not compete at all with the increase of 19 percent per annum, which the S&P 500 Index locked in at the same time.
Copycats destroy the performance
This striking result raises the question of how to explain the huge difference in performance. In that context, Pocinci asks himself whether it could be that a large part of the secular bull market in U.S. equities was supported by endowment envy. He is referring to the following observation: When the historic performance of Harvard and Yale funds became public in 2006, it did not take too long for many endowments and other investors to copy the asset allocation of Harvard and Yale.
According to Pocinci, this development did not come as a surprise, if one compares the performance of the S&P 500 to alternative investments from 1999 until 2006. Back then, the HFRI Equity Hedge gained 11 percent per annum, while both the HFRI Global and the HFRI Macro gained 9 percent. However, the S&P 500 Index came up with an average yearly increase of only 3 percent.
Equities and alternatives swapped places
The balance of forces between 1999 to 2006 was therefore exactly the opposite of what happened between 2009 and 2017. Based on that, Pocinci comes to the following conclusion: “After reading the book and accepting the new asset allocation as the solution to all questions, U.S. endowments walked the talk and moved heavily away from U.S. equities into alternatives. One could say it was equities and alternatives that swapped places as equities moved from 48 percent to 35 percent and alternatives from 35 percent to 53 percent.”
According to Pocinci, it was only logical that Harvard and Yale were unable to repeat their outperformance against all endowments and Ivy League universities. But it was also not surprising that the overall strategy lagged substantially the buy-and-hold returns. This finding should remind investors how essential it is to have a proprietary investment process and how important it is to avoid doing what the crowd does. The result also should remind every investor of the importance of the costs connected with an investment vehicle on the final performance. In that respect, it has to be considered that the average hedge fund charges a 1.50 percent management fee and a 17.5 percent performance fee – a big burden in the attempt to beat the overall market.
Investors still doubt the secular bull market in U.S. equities
Against the backdrop of these elementary investment rules, the outcome of a 2016 survey is unbelievable from Pocinci’s point of view, since it showed that endowments, foundations and other institutions plan to dramatically reduce their allocation to U.S. equities over the next three years. Instead, they intend to invest more money in alternative investment products.
That is a planned behavior that somehow gels with the fact that the equity allocation of U.S. pension funds does not stand far from secular lows similar to those in 1974 and 2009. Behavioral patterns like that can typically be observed at the start, not the end, of a secular bull market. Pocinci interprets all this as an indication that the secular bull market in the S&P 500 Index is set to continue. If that forecast should prove to be right, it remains to be seen whether hedge funds will be able to catch up in the performance contest with the leading U.S. stock market indices like the S&P 500.
If it were up to investing legend Warren Buffet, the answer is already clear. The self-made billionaire recently slammed hedge funds again in an annual letter to shareholders published by his investment company Berkshire Hathaway. Based on the harsh criticism mentioned in there, he is obviously more than ready to renew his bet that a basket of hedge funds will also fail to keep pace with the S&P 500 Index fund.
It will be interesting to follow, whether the hedge fund industry can fight back and prove Buffet wrong.