Hedge fund investments have been described as failing many times before, so the suggestion that the industry is dead or in decline is an “alternative fact,” according to Mark Yusko, CEO and chief investment officer of Morgan Creek Capital Management.
Speaking at the Cayman Alternative Investment Summit in February, the investment adviser said it is at least the fourth time in his career, after the mid-’90s, the Dotcom bubble in 2000 and the financial crisis of 2008, that active management and hedge funds have been declared dead.
“It’s because they underperformed again and there is this stupid thing called smart beta,” he said about the financial products that are marketed as an alternative to the traditional “active” and “passive” investment strategies. During the recent stock market upturn, smart beta and other passive, rule-based investment strategies that track general stock market movements gained in popularity because they delivered similar returns at a much lower cost than actively managed investments.
This, however, is not likely to continue when the stock market turns. “Smart beta is an oxymoron. There is no such thing. Alpha is smart,” Yusko said, referring to the returns that active managers generate in excess of the investment gains caused by general market upswings.
Figures from data provider Hedge Fund Research show that hedge funds returned 5.6 percent on average in 2016, well below the 11 percent gain of the S&P 500 during the period.
For Yaskey, U.S. stocks are significantly overvalued, and thus his forecast for the U.S. stock market is negative. “Everyone believes that stocks always have to go up. It is a physical impossibility to generate double-digit returns from U.S. equities over the next decade. It cannot happen. No way.”
While it is true that hedge funds have been underperforming for eight years, and common belief is that investors want to reduce their hedge fund allocations, now is the best time to be invested in hedge funds, he said, because the correlation between asset classes is falling. In other words, different types of investments are no longer rising and falling at the same time, making it more important to select the right investments and strategies rather than to follow general market developments.
“Hedge funds outperform during periods of crisis and during periods of rising interest rates, both of which everyone is afraid of,” he argued, “so you want to be in those strategies during those times.”
Another “alternative fact,” Yusko said, is that pension funds are leaving hedge funds. “Yet the fact is that pension fund assets are rising from 2015 to 2016. If we believe what we hear or read without checking the facts, we actually believe the business is dying. It is not.”
Despite $100 billion in redemptions last year, the biggest outflow since the financial crisis, hedge fund assets under management have grown to $3.2 trillion, he said.
The hedge fund manager’s reasoning is confirmed by the latest JP Morgan survey of institutional investors, such as pension funds and endowments, in the asset class.
Three-quarters of large investors said they were disappointed by the performance of their hedge fund investments last year. But nearly 90 percent of the 234 surveyed investors plan to increase or maintain their current allocations to hedge funds in 2017.
Some large investors are looking to diversify their portfolio by adding new managers and different strategies, the bank said.
A third of investors ascribed the large outflow of capital last year to overcrowding – too many investment managers pursuing a limited number of investment opportunities – and 20 percent said the difficult macroeconomic environment was responsible for the high number of redemptions.