Hedge Funds Collected $50B to Lag the Market!

Stock market benchmarks recovered some lost ground today. After five straight losing sessions, the S&P 500 index moved back above the 1,800 line.

The bulls took charge after today’s monthly employment numbers confirmed other signs the economy is recovering.

Critically, the market broke out of its "good news is bad news" box today. Positive economic data moved stocks up instead of down. We haven’t seen that combination very much lately.

This may mean Wall Street is ready for the Fed to "taper" the QE3 bond purchases down to zero.

Today I’ll also tell you why those snooty, secretive hedge funds aren’t doing so well this year. In fact, you’re almost certainly better off firing them. I’ll explain why after we look at the jobs numbers.

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The economic recovery is picking up steam. Let’s set the context to today’s employment report.

  • U.S. Gross Domestic Product grew at a 3.6% annualized pace in the third quarter, according to an updated estimate released Thursday.
  • Corporate earnings are still generally positive, and
  • This month’s initial University of Michigan Consumer Sentiment poll jumped sharply, hitting its highest level since July.

Yes, we still have plenty of question marks. As I said Wednesday, even the Federal Reserve sounded uncertain in its latest Beige Book.

Nevertheless, numbers from many sources looks stronger from where we sit today.

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The November Employment Situation Report showed some noticeable improvement. You can read the full report yourself. It shows the unemployment rate dropped to 7.0% last month, with employers creating 203,000 new jobs.

Looking deeper, the details are mostly encouraging, too.

  • The "participation rate" held steady, which means the improvement is not a result of people entering or leaving the labor force.
  • The number of people working "part-time for economic reasons" fell 331,000 last month.
  • Both the average workweek and average hourly earnings ticked higher since last month.
  • Factory overtime hours rose, too, so it looks like businesses want to crank up output.

Not all the news was great. To some degree, the November numbers are simply a reversal of one-time events related to the October government shutdown. Way too many people are still unemployed and underemployed.

Analysts were aware of all those factors and still underestimated jobs growth. That indicates more underlying economic strength than we thought.

For Wall Street, the immediate question is how this data will influence Federal Reserve policy. Most analysts still expect the Fed to end its QE3 program in March 2014.

I won’t be surprised if this week’s positive data makes traders think the Fed will move up the timetable. The Fed’s next policy meeting will be Dec. 17-18.

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Economic recovery or not, workers who can’t do their job usually find themselves looking for new careers.

Hedge fund managers are a big exception to the rule. Those high-paid hotshots somehow hold on to their jobs even when their results are dismal.

But this may be starting to change.

Just a few years ago, wealthy Americans thought Eddie Lampert would be the next Warren Buffett. His ESL Investments hedge fund held more than $15 billion at its peak in 2006.

Between poor results and investor withdrawals, ESL has since lost at least two-thirds of its assets.

This month Lampert had to sell some of the fund’s Sears (SHLD) position to raise cash for investor redemptions. Sears stock dropped on the news.

He had to do the same thing last year, too.

Hedge funds are very secretive about their track records. They don’t have to say much, since they are largely free of government regulations.

A new Bloomberg report says these "exclusive" funds trail the stock market this year by the widest margin in almost a decade.

Through November 2013, hedge fund returns averaged only 7.1%. The S&P 500 index gained 29.1% over the same period, including dividends.

And when you look at performance for these funds for periods longer than a year, the picture looks even worse.

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The subpar results won’t stop those same funds from raking in about $50 billion in management fees industry-wide, according to Bloomberg.

At least one hedge fund heavyweight says investors are rightly disappointed:

Billionaire Stan Druckenmiller, who produced annual returns averaging 30% for more than two decades, last month called the industry’s results a "tragedy" and questioned why investors pay hedge-fund fees for annual gains closer to 8%.

"We were expected to make 20% a year in any market," Druckenmiller, 60, said in a Bloomberg Television interview on Nov. 22, referring to veteran managers such as Michael Steinhardt, Julian Robertson, Paul Tudor Jones and George Soros. "If the market went down more than 20%, we were expected to make more."

The typical fee structure for hedge funds is a 2% annual management fee plus 20% of the profits. That’s supposed to attract top talent and give the managers plenty of incentive to perform.

This year, at least, it didn’t work out that way. Investors would have been far better off with as plain-vanilla index fund. Instead, they’ll pay a 2% fixed fee for the "privilege" of trailing the market.

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Not surprisingly, some hedge fund investors are looking for a better way. Poor performance and high fees aren’t the only problems.

  • Top funds demand very high initial investments, often $1 million or more.
  • Many force investors to sign contracts agreeing to stay in the fund five years or longer, no matter how bad it gets.
  • When they finally let you leave, you’ll likely have to give 90 days’ notice and then wait weeks or months to get what’s left of your money.
  • These "private" funds routinely keep their owners in the dark. Except for a superficial quarterly report, investors have no idea what the manager is doing or how successful it is.

Why would anyone go into these deals in the first place? Usually it was because they saw an attractive track record.

The numbers that drew investors into hedge funds were probably right, but overcoming those outrageous fees and accounting nightmares is tough even for the most-talented traders.

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I think we are in the early stages of seeing a mass exodus from hedge funds.

We hear about it here at Uncommon Wisdom Daily. Wealthy individuals call us to ask about Tony Sagami, Rudy Martin, James DiGeorgia and Geoff Garbacz.

Our in-house experts have track records just as impressive as (or even more than) most hedge fund managers, but without the headaches.

Instead of flying blind, our readers can see every recommendation and decide if it fits into their portfolio before it happens. They can also cancel any time, and our memberships cost much less than those "exclusive" hedge fund fees.

It’s reaching the point where I may soon have to limit access to some of our experts.

I don’t like telling people "no" — but my first obligation is to current subscribers. I would rather keep potential customers on a waiting list than kill the track record for everyone.

It’s too bad the hedge fund industry doesn’t treat their relationship with their customers the same way. At some point, those folks will figure it out.

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I mentioned above that people once compared hedge fund manager Eddie Lampert to famed value investor Warren Buffett. So far, the comparison definitely favors Buffett.

Recently I saw a new research report that attempted to "de-code" Buffett’s success. What is behind his superhuman long-term track record?

The report surprised me. If the professors who wrote this paper are correct, Buffett’s toolbox is surprisingly simple. Better yet, even small investors can apply his core principles. We have been studying systems to "trade like Buffett" since the beginning of the year.

I was planning to tell you a little more about this research today but simply ran out of time. Since next week will be busy for me, too, I’ll try to work on it this evening and send you a special Saturday edition tomorrow to cover some of what we have found.

Watch your e-mail. You won’t want to miss this information.

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Here are your Friday afternoon headlines…

  • The Dow Jones Industrial Average crossed back over the 16,000 level to close at 16,020 today. The Dow set an all-time closing high of 16,097.33 on Nov. 27
  • Some key retailers were in the headlines today, and not in a good way. JC Penney (JCP) dropped -8.7% after disclosing the SEC had demanded information on its liquidity and cash position.
  • Gap (GPS) gave up -1.9%. Despite higher sales, Gap stores discounted key brand names as much as 50% over Thanksgiving weekend.
  • Ulta Beauty (ULTA) wasn’t stylish at all today. The beauty superstore’s stock plunged -20.5% after warning investors to expect lower sales and deep holiday discounts.

Good luck and happy investing,

Brad Hoppmann

Publisher

Uncommon Wisdom Daily