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8 Reasons to be Wary of “Equity Long Short” Funds

Good stuff here from Josh Brown who passes on some thoughts from a hedge fund insider on why equity long short funds might experience more trouble going forward:

  • ELS funds tend to have higher betas than most other strategies (0.60 – 0.80)
  • Crowded trades caused by inflows increase correlation among hedge funds
  • No separation between alpha and beta makes these funds expensive at 2/20
  • Illiquidity, lack of transparency and high fees make long only investments more attractive
  • Funds that incorporate technical and/or macro views may do better than those that don’t
  • ELS has had flat performance over last five years – investors rely too much on past performance
  • Equity markets have reported moderate returns over the last five years – with higher volatility
  • Asset allocation studies by large institutional investors may begin to favor equities again
    • Moderate returns/high volatility (equities) preferred over no return/moderate volatility (hedge funds)
    • Sizable outflows will make hedge funds unstable with even more focus on liquidity
    • Manager talent pool may shrink as some successful managers will elect to close the fund and manage their own capital

I think you could probably generalize about these “challenges” for much of the hedge fund world.  That doesn’t mean it’s always a terrible space to be, but the 2 & 20 world is becoming a very crowded space.  You have to be doing something truly extraordinary to continue to justify that sort of fee structure.  Like, say, what SAC was doing where they were basically cheating.   🙂