Hedge Funds Take a Beating

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Have you ever felt bad about that fixed-price metals contract you placed, only to find a month later the price had dropped? Or had trouble explaining to the VP of purchasing why you didn’t place a resting order last month when this month the metals price jumped 10 percent?

Don’t worry, predicting metals prices is notoriously difficult, and even when you are in possession of oodles of information, making the right decisions can feel as much like placing a bet as it does an informed choice. More to the point, you can take heart that when it goes wrong, you are in good company — or if not good company, at least highly paid company.

The FT reports that the commodities hedge fund industry has suffered its worst year in more than a decade as the sector’s top managers recorded heavy losses amid volatile markets. The average commodity hedge fund fell 1.7 percent in 2011, according to data sourced by the paper, the first loss since the index was created in 2000 and down from a rise of 10.7 percent in 2010.

To be fair, the Reuters-Jefferies CRB Index, a basket of commodities, fell 8.3 percent during the year, weighed down by falling prices for metals and agricultural raw materials. But aren’t hedge funds are supposed to be about making a gain regardless of market direction?

This is not just indicative of poor decision-making, it is a reflection of the fact that an overly narrow focus on the underlying fundamentals can lead to decisions that fail to take into account macro issues.

Mark Rzepczynski, chief executive of the funds group at FourWinds Capital Management, is quoted as saying, “traders who were specialists in a given commodity may have been hurt because they didn’t put enough weight on the risk-off trade. They were disadvantaged because they were looking at specific supply and demand factors.”

The risk-off trade over the last year has been the markets’ reaction to the European debt crisis and fears of slowing growth in China dampening demands for commodities. As money has pulled out of commodities and riskier assets, it has flowed into safe havens like US treasuries – not surprisingly, funds like Brevan Howard, which took a position anticipating falling treasury yields, bucked the industry trend and did rather well.

Possibly as an illustration of what the future holds, funds controlled by computer-driven strategies have been some of the best performers. According to this report, DE Shaw, founded by mathematician David Shaw, has seen its flagship Oculus fund return 18.5 percent this year, while Renaissance Technologies has seen its computer-driven institutional equities fund return 30 percent so far this year, and Quantitative Investment Management, achieved a return of 41.4 percent in the past 11 months.

A few commodities-based funds have managed to prosper in spite of difficult times. Velite, a natural gas fund, gained 51 percent, while Galena Metals posted a gain of 11 percent and Red Kite, a longtime bear on copper, also posted gains following the sell-off since the summer. For some hedgies, particularly the smaller funds, it has been a difficult few years with profits not exceeding the +20 percent watermark, where funds can charge their investors performance fees.

If anything, we take heart that MetalMiner’s mix of macroeconomic news, industry trends and developments, and specific metal market reporting seems to mirror the approach taken by the most successful hedge funds, who have in-depth product knowledge yet also allow for broader macro influences in their decision-making.

–Stuart Burns

Comment (1)

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