Hedge Fund Managers Paid for Stockpicking Genius Aren’t Showing Much of It

But the performance of these would-be wizards has slipped, just when their clients need them to soften the blows from the most ferocious market selloff in more than a decade. Equity hedge funds are down 15% this year, according to data compiled by Bloomberg. Chase Coleman’s Tiger Global is in the worst shape among large players, losing almost 52%. Dan Sundheim’s D1 Capital Partners has slumped 28%, and Ross Turner’s Pelham Capital is down 32.5%. Lone Pine Capital, run by Steve Mandel, has seen firmwide assets slump 42%, to $16.7 billion.

Discouraged investors are pulling billions of dollars from long-short equity funds. They took out $25 billion through August, the most for any hedge fund style this year, according to fund data tracker EVestment. Net withdrawals over five years have exceeded $100 billion. While long-short funds still dominate the $4 trillion industry, with about $683 billion in assets, they’re close to being overtaken by so-called multi-strategy funds, which invest across multiple asset classes and are often run by teams of less famous, more replaceable managers. The assets-under-management gap between the two strategies shrunk to the lowest-ever level of about $27 billion in August, from $235 billion just a year ago, according to EVestment.

The decline of long-short equity hedge funds has been years in the making. Part of the problem may be that they got out of the habit of hedging. Many managers’ tactics were honed during a decade of low interest rates that powered rising share prices. They could make money with leveraged bets on high-flying stocks. Even so, as a group, equity hedge funds underperformed a simple S&P 500 index fund in strong bull market years like 2013 and 2019. Now portfolios loaded with growth and technology shares and just a smattering of shorts have captured most of the downside in this market.

“Who thought it was a good idea to pay away 20% of profits to guys who simply went long tech stocks?” says Andrew Beer, founder of New York-based Dynamic Beta Investments, which attempts to replicate hedge fund-type returns at low cost. “The hedge fund fee structure has been a dream for managers and nightmare for investors.”

The ability to short stocks—borrowing shares and selling them, hoping to buy them back later at a lower price—differentiates hedge funds from mutual funds and exchange-traded funds. But shorting hasn’t worked for a majority of stockpickers in the past decade. Near-zero interest rates over much of that time helped even the weakest companies stay afloat and encouraged companies to borrow money to buy back their own shares, helping to keep stock prices elevated. Low interest rates also meant that short-selling funds were being paid less on cash they held after temporarily selling shares, even as they were missing out on the stocks’ dividends, making the tactic more costly.

Managers haven’t done very well at sorting the best companies from the worst either. Two indexes compiled by Goldman Sachs Group Inc. of the favorite bets of hedge funds show that, during major market declines, their long picks have fared worse than their shorts. And in periods when the market was climbing, the stocks they shorted rose, too. This year, hedge funds’ favorite stocks are down about 31%, and the ones they’re shorting have declined only 20%. In other words, as a group, hedge funds are losing more on the stocks they thought would go up than they’re making back on the ones they thought would go down.

Jillian McIntyre, the founder of 221B Capital Partners who once ran short-selling research at billionaire investor Chris Hohn’s hedge fund, blames the poor showing on a diminishing pool of talent. In a long bull market, there was little incentive for money managers to develop analysts with a nose for spotting flawed companies. “In 2021, the absolute number of short sellers declined and may have hit a low point,” says McIntyre, who named her firm after the Baker Street address of Sherlock Holmes. She notes that short sellers have also come under more scrutiny from US authorities, making it a riskier business.

Retail investors armed with commission-free brokerage accounts and social media savvy added to short sellers’ woes. They banded together last year to push up the prices of widely shorted stocks such as GameStop Corp. and AMC Entertainment Holdings Inc. Hedge fund wunderkind Gabe Plotkin shut down his Melvin Capital Management after getting on the wrong side of this retail meme stock boom and losing more than half of his assets. Andrew Left’s Citron Research said last year it will discontinue offering short-selling analysis after 20 years of providing the service.

There’s also been a glut of long-short hedge funds, meaning more traders are chasing the same opportunities. More than a third of the 8,000 or so hedge fund managers tracked by the research company Preqin specialize in betting for and against stocks. “Crowding; retail investors becoming much more sophisticated, agile, and organized; and interest rates being so low have been major headwinds for long-short equity hedge funds,” says Edoardo Rulli, deputy chief investment officer of UBS Group AG’s Hedge Fund Solutions business, which invests in the funds on behalf of clients. “The last one is going to go away. The other two are still there. So let’s see.”

There are still hundreds of billions of dollars riding on individual stockpickers. And there’s still demand for equity-investing skill inside mega multi-strategy investment firms such as Millennium Management and Point72 Asset Management—it’s just that those managers generally don’t get to put their names on the door and have bosses who can fire them. Managers willing to make concentrated bets or focus on niche sectors such as biotech can still thrive on their own. So can those who maintain a balance of long and short positions to make their funds less correlated to indexes such as the S&P 500. The $24.4 billion Eureka fund, run by London hedge fund Marshall Wace, told clients last month that its net market exposure was close to zero and reported a 4.2% gain through September of this year, according to investor documents.

More than half of the long-short managers reporting performance numbers to Bloomberg as of Sept. 22 lost 10% or more this year, and 80% of them are down. Even some of those with strong track records are giving up. Sean Gambino, who founded Heron Bay Capital in 2015, produced an annualized gain of 18.6% to beat the S&P 500 since the fund’s 2015 launch. Still, he shuttered his hedge fund and moved with his team to the bigger multi-strategy hedge fund Eisler Capital on Sept. 1. Raising capital has been “extremely difficult” for single-manager funds that don’t already have huge asset bases, he told clients.

About 140 new long-short equity hedge funds have started this year. While this may seem like growth, it compares with an average of more than 550 annually in the previous 10 years, Preqin data show. Rulli of UBS, one of the most influential backers of hedge funds, says a reset in the industry may be coming, leaving only the stronger players standing. “Formation of new funds will go down; the number of funds will possibly shrink,” he says. “It’s not a bad thing.”

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