Why the Hedge Fund World’s “All-Stars” are Struggling…

Both the Financial Times and Market Folly recently highlighted the recent sub-par performance of some of the world’s top hedge funds.

The S&P 500’s rally of 8.6% this year notwithstanding, the all-stars of the hedge fund world are having a rough start to 2010. Now these hedge funds aren’t the industry’s one hit wonders. They are the Babe Ruth’s of the game. Moore Capital management- whose Louis Bacon has his London digs (OK…more like a palace) right around the corner from me- has only posted gains of 1.58% this year- despite climbing to the top of the U.K.’s “hedge fund rich list” this year with a personal fortune of 1.1 billion British pounds. Last year’s star of the hedge fund the London scene, emerging market manager Greg Coffey who famously left a $200 million bonus on the table at European hedge fund GLG back in 2008- was down 5.88% into mid March. Having recently¬† sat next to the senior macro trader at Tudor Investments at a recent dinner at the swanky Carlton Club, the mood there is scarcely better. Turns out the Tudor BVI Global fund was down 0.55% to mid-March.

This sub-par performance has left investors scratching their heads.

Here are my thoughts. Unlike retail investors, global macro hedge funds- or “multi-strategy funds” aren’t necessarily focused on the U.S stock market. Global stock markets- including emerging markets and the formerly high octane BRICs– are barely above water this year, thanks in part to the rallying U.S. dollar. Few financial bets- except maybe a bet against the euro and the GBP- have yielded big payoffs.

But the real reason is hedge funds are struggling is that hedge fund managers look at risk in a fundamentally different way than retail investors, for whom “buy and hold” remains the dominant investment mantra- the strategy that has worked best over the past 14 months. But after a paradigm shifting 2008, hedge funds are understandably skittish. They are (rightly) worried focused on the downside risks- whether financial contagion from Greece or another “Black Swan” event which by definition they cannot predict.

That’s why many funds went into defensive mode after the sharp sell-off in January. And they have been scrambling to recover ever since, as the market has turned back up. And after an eight consecutive weeks rally in the U.S. markets, the sharpness and suddenness of the January sell-off has faded into distant memory. For U.S. investors glued to the live video game that is CNBC,¬† “fear” has rapidly transformed into “greed.” As the economist John Kenneth Galbraith observed: “The financial memory is very short.”

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