Isn’t A “Long Only” Hedge Fund A Mutual Fund?

The news from Monday’s November 11  Wall Street Journal on p C1 is that hedge funds who are shorting stocks are underperforming the market and most mutual finds. In this article, Juliet Chung points out that the new “Long Only” funds “may represent a shift by hedge fund managers …..into the kind of old fashioned stock picking more associated with Main Street mutual funds”. The article asks whether this means that  classic hedge funds are competing for fees or if it is a contrarian sign of a top in the market.The article points out that the S&P is up 25.3%  through October 2013 compared to 11.3% for hedge funds according to HFR.

Review the performance of your favorite mutual funds and various sectors of the market over the past three years but in general hedge funds have an annual average return of only 3.88% over 3 years compared to 15% a year for the S&P.If you have been reading you know that the biotech sector (IBB) is up over 191% over five years; the Russell 2000 Index ETF (IWM $109.48) is up 116% over five years and the NASDAQ over 138%. With these huge returns hedging looks to be  a fruitless task. The math is simple, in a raging bull market it is hard to beat the indices. The best hedge in 2013 would be to allocate less money to bonds and more to equities as corporate bonds (LQD) are down an average of 6% YTD. The bond bull market is 31 years old. High Yield bond funds have fared better but still flat in 2013. The Four Star Fidelity Strategic Income Fund (FSICX) is also flat YTD and a total return of 26% over 5 years. This compares to an average Taxable Bond Return of 5.4% over 5 years .

Here is some Lipper Fund Data by Category over 5 years through Q3 2013.  Returns are average annual return % :

Global Stock Funds 8.2%,  Large Cap Growth 10.5%,  Mid-Cap growth 12.3%,  Small Cap growth 13.3%

Health/Biotechnology 16.4%,  Science and Technology 12.6%,  Telecom 9.5%.

Why Is Shorting Stocks Or Even Hedging With Shorts Risky?

Of course if the market is soaring even your best short idea may be a loser. Consider the following:

  1. Some hedge fund managers look for high short interest as a buy target because if the stock is illiquid with a small float the stock can squeezed for gains.
  2. Funds that are already long the stock in their portfolio can support the stock from downdrafts and sell-offs. Also it can take a long time for overvalued stocks to fall so timing may be difficult.
  3. Within the biotechnology sector for example, all types of funds small and large cap, growth and value are buying relatively unknown companies for the first time. Because of money flowing into the sector all types of funds need to buy life science stocks to keep up with overall category performance.
  4. Speculation and momentum investing is rampant so fundamentals and valuations matter less. News drives stocks.Buzz travels fast.
  5. Many smaller companies control their float or the ability to borrow stock for shorting.There may be a fee for borrowing stock.

Nonetheless the time will come for boosting portfolio returns through hedging. The most likely sectors for shorting would be biotech and internet stocks as they are the most frothy.For now with the market tailwind and a recovering economy it is prudent to stay long as the trend is your friend.

Also published in Seeking Alpha this pm.



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