Hedge Funds Finally Nose Past the S&P 500

Hedge funds are finally edging past the S&P 500, a welcome plus for an asset class that has taken heat for underperforming in recent years amid the bull market.

The hedge fund composite had a very good November and ended up gaining 13.27% for 2020, versus 12.1% for the benchmark stock index, according to Preqin research.

What’s more, equity strategies, the class’ largest, did even better, up 14.49% for the year. Poorer showings in the past have sparked criticism because hedge funds’ relatively high fees didn’t deliver what a low-cost index fund did. Redemptions and fund closings have been rife, with even celebrated hedge operator John Paulson calling it quits in July.

Although hedge fund afficionados argue that hedge funds provide diversification and shouldn’t be judged against the stock market, many investors disagree. Hedge funds remain a key part of many pension funds’ alternative investments portfolio.

Stock-oriented hedge funds aim to ride hot momentum plays, but also to do a fair amount of shorting, betting on drops—a combo technique known as long/short. While stocks have surged since their February-March debacle, they’ve also done so with a lot of volatility, helped by an influx of retail investors of the Robinhood variety.

Result: happier hunting grounds for sharp hedgies as momentary darlings have tumbled. The climate for hedge funds, wrote Russell Barlow, global head of alternative investment strategies at Aberdeen Standard, in a report, is “attractive for long/short stock picking, as correlation between stocks has fallen since the peak of the crisis and volumes driven by retail traders have surged, creating inefficiencies in market pricing.”

Another hedge category, global macro (focused on currencies, interest rates, and other things affected by international economic trends), hasn’t done very well thus far this year, up 8.9%. Barlow, however, said he expects its prospects to brighten. Global macro, he indicated, is “an area in which we expect opportunities to arise as the policy response to COVID-19 varies across different countries.”

In terms of stocks, it’s intriguing that hedge funds’ 50 top picks did even better than the funds that own them. For 2020 through November, Goldman Sachs’ Hedge Fund VIP list of such names was up almost 40%. Its three largest holdings are exercise gear maker Peloton Interactive, Latin American ecommerce platform MercadoLibre, and social media giant Twitter.

Like the stock market as a whole, hedge funds like battered leisure stocks, evidently believing that these will romp further once the pandemic is over. A large such holdings for the hedgies is casino owner Caesars Entertainment.  

Activist funds, which take positions in companies and agitate to make the businesses more profitable, also have done well of late, almost equaling the S&P 500. They lagged all year and then had a strong November. The same situation prevails for emerging market specialists, which anticipate a recovery in commodity prices due to an expected worldwide recovery and China’s current rebound.

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