Hedge Funds Late to Party, Again, Running Flat in March Per BoAML

ESL INVESTMENTSHedge fund managers make a fortune calling the shots for their funds. Most charge 2-and-20-percent – 2 percent for management and 20 percent for performance – and, while they generally they earn every penny, lately not so much.

I still think hedge funds are worth watching, especially when it comes to their top picks – after all when you have millions, if not billions, invested in a company, the decision was certainly not arbitrary. Hedge fund managers usually have full staffs at their disposals, sometimes of hundreds, to research and analyze the markets so that they can make the best decisions for their funds – and they usually do a great job. For instance, Eddie Lampert's top eight picks returns over 44% in 2011 while hedge fund manager Bruce Berkowitz's top 16 picks were able to generate a return of roughly 36%, while the market was relatively flat. Unfortunately, performance like Lampert's and Berkowitz's has been the exception lately.

Some of the top hedge funds in the world lost significant sums last year. John Paulson's flagship fund lost over 50% last year, Philippe Jabre's Global Balanced Fund fell almost 27% and Whitney Tilson's T2 Partners lost just under 25%. Blame it on a volatile market, but the markets have been rallying lately – returning over 10% year-to-date – and hedge fund performance is still suffering. Bloomberg Businessweek reports that hedge funds have underperformed the S&P 500 since the rally in November, and, according to the Bank of America Merrill Lynch investable composite index, hedge funds have been nearly flat for the month of March through the 21st. Event-driven funds are up 0.57% so far for March. Merger arbitrage funds are doing almost as well, they are up 0.43%. Performance is worst amongst market neutral funds, which are down 1.19% so far this month.

Now, hedge funds are buying more aggressively to make up for lost time. According to the International Strategy & Investment Group, the percentage of hedge funds taking long bets on stocks rose to 48.6% last week, from 42% five months ago. This could mean that they are coming on board and adopting a slightly more bullish outlook of the market, albeit a bit late to the punch. The economy is recovering and there is every reason to think that its growth will continue.

But, there could be another issue at hand – shorts.

Many of the stocks that companies were shorting most – stocks like Netflix (NFLX), Bank of America (BAC) and Sears (SHLD) – have been some of the top performers so far this year. Netflix has returned over 66% to date while Bank of America's share price has gone up over 70%. Sears is up over 130%. Those fund managers that took large short positions against them are now forced to buy positions in an attempt to cover their losing positions. “Hedge funds are at least part of the underlying strength in the recent move [in the stock market], and it has to do with not only buying stocks, but first and foremost covering,” says founder of Holland & Co, Michael Holland.  “It’s been a brutal time to be on the short side.”

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