Changing of the Guard for Hedge Funds

As reported by Forbes, the dynamics of the hedge fund industry are changing and so are the managers. The days of expert networks, massive fund inflows and controlled trading are history. Hedge funds are seeing outflows compared with other  investments, like high frequency trading funds and ETFs with lower fees. For the traders at mediocre hedge funds, it’s exit time. 

A common hedge fund strategy in 2012 is to overweight in Apple (NASDAQ:AAPL). For many of the top performing funds, the performance can be attributed to concentration in Apple holdings, which are up 50% in the first quarter. UBS estimates the S&P 500′s Q1 2012 earnings could rise  twice as fast with Apple as without it. The star of tech sector is widening the gap from the rest according to Barclay’s Capital (tech.fortune.cnn.com). The extraordinary performance of Apple has been crucial to hedge funds.

 Uncorrelated + Uncorrelated + Uncorrelated = Correlated

Many hedge funds claim to have a “diversified model” with a variety of stocks or assets. The problem is most funds diversify with the same strategy, so what shouldn’t be correlated can become highly correlated in the aggregate. Crowded holdings can add risk or lead to systemic breakdowns, as we saw in the banking crisis when the  funds were chasing the same trade. Investors are beginning to resist high fees for look-alike funds that ironically can deliver sub-par performance with very high risk. 

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