It's A Deal
September 15, 2009
When Good News Is Bad
As Wall Street rehashes the anniversary of the fall of Lehman, we're left wondering if the nascent recovery in various markets has caused the powers that be to take their eyes off the regulatory ball.
We tackle that idea in this week's cover story, and the sentiment is neatly summed up by Henry Kaufman, the renowned economist and a former board member of Lehman, who notes that as the economy stabilizes "there will be less fervor to re-examine forces that contributed to the financial crisis."
It's a growing sentiment as it relates to the global economy, but the hedge fund world may have its very own version of "good news might be bad news" going on, at least if one prominent observer has read the industry correctly.
Rich Bernstein, formerly the chief investment strategist at Merrill Lynch who now runs his own shop, Richard Bernstein Capital Management, says the bounce in returns at alternative investment shops is no cause for celebration.
"I hate to the spoil the party," he warned yesterday, "but the fact that hedge funds' returns have improved is actually bad news. In the short-term, of course, their renewed performance is good news. However, their recent performance makes the longer-term outlook more negative for both the hedge funds industry and the hedge fund as an asset class."
His thinking goes like this: In an industry where there are inarguably too many players, strong performance actually delays the necessary paring down of hedge fund shops. Until the weak managers are run through the chopping block, investors can't count on original ideas from their fund managers, ideas that will outperform the broader stock market.
Along those lines, Bernstein has found that so-called uncorrelated assets are in fact becoming increasingly correlated to the S&P 500. In other words, why bother with 2/20 when you can pay Fidelity or Vanguard 0.8% a year?
Bernstein's other concern is the increased use of leverage. (That can't get you in trouble, can it?) He tells the story of a prime broker whose firm was offering leverage as high as 15x to its best clients. So, it's not stock selection but instead taking on greater risk that's driving outperformance.
"The problem seems to be that most investors have yet to understand how rare [exceptional] managers are, and that a levered or collared index fund might outperform most hedge funds, and do so more cheaply," he says. "Sadly, the current rebound in hedge fund performance is likely to reinforce the widespread misconception that there is something advantageous to investing in hedge funds."
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