it’s because they got the trade wrong

yesterday Bloomberg was reporting the annual ranking of HF manager earnings by AR Magazine and the severity of the 35% drop…   to Average pay for the 25 top earners was $576 million last year, down from $883 million in 2010, according to an annual ranking published by AR Magazine. In 2009, the figure stood at $1.1 billion.

That’s insane, especially when you consider this:  Hedge funds posted an average decline of 5.3 percent last year, a negative annual performance exceeded only by the 19 percent drop in 2008, according to Hedge Fund Research Inc.

and this:  Eleven hedge fund managers were placed on the AR Magazine list of 25 highest earners even though their firms posted single-digit investment returns. The publication attributed this to managers benefitting from fees charged to investors and to managers putting their own assets in their hedge funds.

Clearly some managers such as Dalio and Icahn performed and earned their payout.  Who wouldn’t want either of those guys managing their capital.  The bigger tell is that an asset class could produce an average 500bps under-performance v the S&P 500 which was flat and the 2000bps v the 10YR which had its best year since 1995 would pay out half a billion in fees on average to the top 25 managers.  This doesn’t even count private equity.  It speaks the the sheer size of the asset class.  In fact it’s quite possible today HFs have become so large they now represent the class of investors who they used to bet against.  Then are they are now betting against themselves?

One thing is for sure, the under-performance can be attributed to a trading miscalculation in the equity market and it might still be in play.  After riding the easiest trade in history, the QE II “reflation correlation” HFs were all caught long the Risk-On/Off and when the Fed turned off the printing press the trade crashed.  Then thinking it was 2008 redux HF’s inverted Risk-On/Off and went short stocks despite the widest equity risk premium since the 1974 low.  With Q1 in the bag turning in at 12% performance the speculative community remains net short $ES_F.  They have remained short for 33 weeks and a 30% rally from the Oct 4 low to Friday’s close.

Chart: Bloomberg

We think it’s pretty clear the market is being levitated by a short squeeze whether outright short of just short from a weighting perspective after a major asset allocation shift in retail.  We get retail bailing, but why does the “smart” money miss it so badly?  For one they are all using the same playbook and two they are too focused on ex post analysis of data without regard to discount and flow.

We have often described this market as a Market on a Mission.  The mission is to heal the wounds left behind by the Credit Bubble and Financial Crisis as represented by the implosions of Bear Stearns and then Lehman which were the climactic events in the past decade of leverage.  Put simply, we think the crisis was about flushing the leverage and the rally is about a retracement of that flush.  We are in the midst of a giant snap-back rally after a massive balance sheet capitulation.

Eventually the economy will have to perform to support a continuing bull market and when interest rates normalize or at least go positive the multiple which has been a major catalyst since last fall will be under pressure.  Earnings are going to grow on average at the rate of nominal GDP and we just don’t see much more than 4-5% over the near future but if reflexivity is real then a rising stock market can produce growth and if it’s not inflated by a weak dollar the multiple should respond.

We aren’t sure 2009 was the low in price and 2011 was the low in risk premium but we are pretty sure that when we do put in THE low of this bear market no one will be on board and no one is on board this market.




About exantefactor

capital market veteran of over 15 years covering multiple asset classes. Focused on analyzying markets ex ante (before the event).
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