Hedge Fund "Pack Behavior" Nothing New
In World War II, the German Navy created a strategy where a bunch of submarines - known as "U-boats" - would travel together and attack an enemy ship at the same time. They became known as "wolfpacks." Wolves travel in packs, so I guess that's where the name came from.
Last week, the Wall Street Journal carried a story about hedge funds that exhibit "pack behavior." The article claims that funds have started jumping on and off trades all together, causing a lot of up and down swings in the price of some stocks that's abnormal. So they kind of travel together and attack at the same time like wolfpacks. It's not a bad article, but it exaggerates the "pack behavior" idea. (You can read the article by clicking here.)
First of all, the article points out that, since the 2008 stock market collapse, hedge funds have underperformed the S&P. And that's created a dilemma because hedge funds charge very high fees. Why pay up to underperform the plain old S&P?
The problem with that statement is that it implies that "hedge funds" - as a class - seek to outperform the S&P. That's not true. Hedge funds pursue all sorts of investment strategies. Some do outperform the S&P on a consistent basis - and still do. Some tell you they may not perform as well as the general stock market when stocks are hot, but they won't lose money when stocks drop. And there are all kinds of other strategies out there.
So one problem with the article is that it kind of lumps all hedge funds under one umbrella. And that's not accurate.
What about the point regarding "pack behavior"? Well, that kind of puzzled me because some hedge funds have always been trend followers. As a matter of fact, long before hedge funds existed, there were (and still are) individual professional traders who jumped on trends. They would ride a stock up, then ride it down. The really skilled traders try to make money by going "long" a stock when it's going up; then they might continue to make money by going "short" if the stock heads down. And, let's face it, lots of stocks do go up only to head right back down again after a short time.
So hedge funds that trade this way are really nothing more than entities that do just what individual traders have done since the beginning of stock markets. If you study the history of the stock market - whether it's the New York Stock Exchange, the London exchange, Paris, Frankfurt, wherever - you find traders who push stock prices up, or push them down, or do both: up, then down; or maybe, down then up.
What's maybe different about hedge funds that trade this way is that they control larger pools of money than any individual does, and so they jerk the price of a stock up and down more than any individuals might. But the idea that they jump on a trade that's heading up, or that's heading down is really nothing new.
If there's anything about hedge funds that struck me during the 2008 market collapse, it's that many funds that claimed they would protect you stocks went down didn't do that. They lost money - some lost a lot. In effect, they didn't "hedge." So why do they call themselves "hedge" funds?
The bottom line to this is that the term "hedge fund" really does not indicate that a fund is hedging at all. For example, there are hedge funds that simply invest "long" in stocks. They don't offset their long investments by shorting stocks or using options, or really doing anything specific to hedge their risk. If the general stock market heads down with a vengeance, like it did in 2008, their stocks will head down too. Where's the hedging? Why do they call themselves "hedge funds"?
So, in the end, if you invest in a "hedge fund," all that really means is that you're investing in a partnership where you are one of several or many partners who put money into a fund that invests your money. And hedge funds charge very high fees.
If you find a hedge fund that does something you understand, that makes sense to you (whether or not they hedge their risks in any way), and you think what they do is worth the high fees, then by all means invest in hedge funds. I, for one, see very few - if any - funds that are worth the expense.
Last week, the Wall Street Journal carried a story about hedge funds that exhibit "pack behavior." The article claims that funds have started jumping on and off trades all together, causing a lot of up and down swings in the price of some stocks that's abnormal. So they kind of travel together and attack at the same time like wolfpacks. It's not a bad article, but it exaggerates the "pack behavior" idea. (You can read the article by clicking here.)
First of all, the article points out that, since the 2008 stock market collapse, hedge funds have underperformed the S&P. And that's created a dilemma because hedge funds charge very high fees. Why pay up to underperform the plain old S&P?
The problem with that statement is that it implies that "hedge funds" - as a class - seek to outperform the S&P. That's not true. Hedge funds pursue all sorts of investment strategies. Some do outperform the S&P on a consistent basis - and still do. Some tell you they may not perform as well as the general stock market when stocks are hot, but they won't lose money when stocks drop. And there are all kinds of other strategies out there.
So one problem with the article is that it kind of lumps all hedge funds under one umbrella. And that's not accurate.
What about the point regarding "pack behavior"? Well, that kind of puzzled me because some hedge funds have always been trend followers. As a matter of fact, long before hedge funds existed, there were (and still are) individual professional traders who jumped on trends. They would ride a stock up, then ride it down. The really skilled traders try to make money by going "long" a stock when it's going up; then they might continue to make money by going "short" if the stock heads down. And, let's face it, lots of stocks do go up only to head right back down again after a short time.
So hedge funds that trade this way are really nothing more than entities that do just what individual traders have done since the beginning of stock markets. If you study the history of the stock market - whether it's the New York Stock Exchange, the London exchange, Paris, Frankfurt, wherever - you find traders who push stock prices up, or push them down, or do both: up, then down; or maybe, down then up.
What's maybe different about hedge funds that trade this way is that they control larger pools of money than any individual does, and so they jerk the price of a stock up and down more than any individuals might. But the idea that they jump on a trade that's heading up, or that's heading down is really nothing new.
If there's anything about hedge funds that struck me during the 2008 market collapse, it's that many funds that claimed they would protect you stocks went down didn't do that. They lost money - some lost a lot. In effect, they didn't "hedge." So why do they call themselves "hedge" funds?
The bottom line to this is that the term "hedge fund" really does not indicate that a fund is hedging at all. For example, there are hedge funds that simply invest "long" in stocks. They don't offset their long investments by shorting stocks or using options, or really doing anything specific to hedge their risk. If the general stock market heads down with a vengeance, like it did in 2008, their stocks will head down too. Where's the hedging? Why do they call themselves "hedge funds"?
So, in the end, if you invest in a "hedge fund," all that really means is that you're investing in a partnership where you are one of several or many partners who put money into a fund that invests your money. And hedge funds charge very high fees.
If you find a hedge fund that does something you understand, that makes sense to you (whether or not they hedge their risks in any way), and you think what they do is worth the high fees, then by all means invest in hedge funds. I, for one, see very few - if any - funds that are worth the expense.
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