Hedge funds haven’t outperformed the broader U.S. market in a long time, and with 2019 continuing the streak, large investors are expected to move money into a class of stocks that didn’t do so well in 2019 either: smaller caps.
The Barclays Hedge Fund Index shows a 2019 return of 10.72%, a whimper compared with the S&P 500’s 27% return for the year. That’s no departure from the hedge fund index’s 2017 return of 10.36%, compared with the S&P 500’s 20%. And in 2018, hedge funds lost 5.2%, less than the broader market’s loss of 7%, but nobody likes to lose money.
Still, pension funds are “going to continue to put money into hedge funds,” said Don Steinbrugge, hedge-fund manager and founder of consultant Agecroft Partners.
“Pension funds have to be diversified, and on the equities side, when you add together marketable equities, private equities, real estate equity, they’re pretty much maxed out. So their alternative is to invest in fixed-income, and when you look at yields outside the U.S. — close to zero.
“Pension funds are going to take some money out of their fixed-income allocation and move it into hedge funds to enhance return.”
Even in the U.S., yields offer subpar return. The 10-year treasury yield is less than 2%. With inflation at roughly 1.6%, the real return on safe U.S. bonds offers nothing attractive compared with other sources of income, though those sources may be slightly riskier.
Other institutional fund managers have told TheStreet that many pension funds still haven’t had enough incentive to move away from low-yielding government debt. Now, Steinbrugge says, they may have to move away.
But to where?
Long/short large-cap funds — which comprise just under 30% of the business — will see outflows, Steinbrugge’s research suggests. A long position is when a fund buys a stock and bets the price will rise. Shorting is betting the stock will fall. Long/short funds bet on whichever direction they think a stock will move.
“A lot of long/short equity managers that focus on very-large-cap U.S. stocks are losing money. There’s a rotation into long/short equity strategies that focus on small-cap stocks and emerging markets,” Steinbrugge said.
He added that funds focused on tech or healthcare are “where the money is going.”
Small-cap investors saw the Russell 2000 small-cap index rise 15% last year, underperforming the S&P 500’s 27% gain. The Russell 3000 saw a 24% gain.
The NYSE Healthcare Index rose 18% in 2019, with the MSCI Emerging Market index up 13%.