Analysis: The great hedge fund humbling of 2011

Wed Jan 11, 2012 11:13am EST
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By Svea Herbst and Katya Wachtel

BOSTON/NEW YORK (Reuters) - Excuses, excuses and more excuses.

Some of the best-known hedge fund managers have offered lots of excuses for underperforming the major stock market indexes last year, with many large funds posting double-digit losses.

In letters to investors, managers pointed to things like Europe's debt crisis, a slower-than-expected economic recovery in the United States, and unforeseen events like Japan's nuclear disaster all coming together to create a tricky trading environment that was characterized by big and often unpredictable swings in stock prices.

The result was a humbling year for the $1.7 trillion hedge fund industry, with the average fund dropping 4.8 percent and some stock-focused funds suffering an average 19 percent decline, according to research compiled by Hedge Fund Research and Bank of America Merrill Lynch analysts.

Investors who sidestepped hedge funds and instead chose mutual funds fared much better. For example, the Vanguard 500 Index fund gained 2 percent, and PIMCO's StocksPLUS Long Duration Fund, 2011's best performing mutual fund, enjoyed a 21.2 percent return.

Not everyone is buying the hedge fund managers' excuses. These skeptics are saying that no matter how smart the managers may be, they are prone to make mistakes just like everyone else and are not necessarily blessed with perpetual special insight into markets.

Industry observers say what tripped up many famous managers in 2011 was that far too many traders were piling into the same large stocks.

"Investors anoint a new hedge fund demi-god all the time," said professor Jim Liew, who teaches hedge fund strategies at New York University's Stern School of Business. "But they are bound to be disappointed because the rule of thumb is that a manager who can be up 40 percent one year can be down 40 percent the next. They are absolutely human."   Continued...