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Hedge fund managers have the lamest excuses for why they stink right now

Jul 11, 2016, 20:59 IST

Flickr/orvalrochefort

Likely, you've heard that 2016 has been a miserable year for the hedge fund industry. The Masters of the Universe have been beaten down by volatile markets and low interest rates. Their clients are asking to have their fees reduced. Shops are shutting down.

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And so Morgan Stanley decided to ask a group of hedge fund managers in the business of picking stocks what, exactly, they think their problem is.

Here's what they said, according to Morgan Stanley (emphasis ours):

"The answers were: 54% said 'crowding', 23% said 'factor exposures', 8% blamed 'macro headwinds' and 8% said 'poor liquidity'.

The remaining group (also 8%) said 'poor stock selection'. In other words, when performance is bad, it is beta, when performance is good, it is alpha.

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The truth is that 100%, at some level, should have said 'poor stock selection', and what these data reveal is that 92% of respondents are blaming something other than their stock selection methodology for the current underperformance. Our portfolio has outperformed for five straight years, and is lagging this year. It is 100% stock selection."

Yes, you heard it here first people: The Masters of the Universe do not want to take responsibility for picking crappy stocks. What's more, their answers reflect that they think that when they outperform the market, it's because of their stock picking prowess. When they don't, it's everything else's fault.

Even the BSDs

Now to be fair, even some of the most brilliant people in the market have said that the number one cause cited for underperformance - crowding - has been an issue this year.

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Back in May, Steve Cohen, the founder of Point 72 Asset Management, said that crowding when the market went haywire in February made his worst nightmares a reality.

"One of my biggest worries is that there are so many players out there trying to do the same strategies ... if one big one goes down, will we take collateral damage?" Cohen said at the Milken Institute Global Conference in Los Angeles. "We were down 8% in February and for us that's a lot ... my worst fears were realized."

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On that same panel, Neil Chriss of Hutchin Hill Capital pointed out that the hedge fund industry used to be worth a few hundred million. Today, the industry is worth $3 trillion. For years everyone has thought bigger is better, an idea that works until you have to move money around fast in a market that's turned against you.

And that's the real kicker here. Hedge funds are supposed to be uncorrelated to the market, and ideally uncorrelated to each other. Crowding isn't just about too much money in the industry, it's about too few ideas. In May, Goldman Sachs pointed out that in an upmarket, the stocks that hedge funds are crowded into tend to outperform. If you go with that same strategy now, you get spanked.

Morgan Stanley talked about this in their report. Instead of accepting the reasons hedge fund managers had given for underperformance, the bank decided to come up with some of its own. One of them was "group think." It's sort of another way to say crowding, except that "crowding" is something that just happens. It seems like a passive action.

Falling prey to group think, though, is not something that just happens. It's a violation of the hedge fund manager's responsibility to do their own homework.

But of course, no one worries about that when the market is going up and the Tiger Cubs, the famed hedge funds seeded by legendary investor Julian Roberston, are starting long-only unhedged-hedge funds to chase the market's momentum with size.

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Nope. Everything's totally cool then.

Responsibility

You might think that in the macho world of Wall Street, there would be some sort of code - an unwritten rule that Masters of the Universe have to take responsibility for their actions.

You would be wrong about that. There is a culture about being right. That means when things go wrong, you still have to be right, or people lose faith in your ability. And if they lose faith in you, you will make less money. It's that simple.

The Harvard Business Review was harping on this during the financial crisis, so this isn't a new concept on Wall Street.

It's just one that Wall Streeters have a hard time grasping.

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"Behavioral scientists teach us that the first step in recovery is an acknowledgement of responsibility," John Baldoni wrote for HBR back in 2008.

"But sadly too few executives are holding themselves accountable. This is not only bad for the future of our economy. It sets a poor example to younger managers and those about to become managers. Forget what you might have learned in school (or from your parents), these executives seem to say, do what you want to do and deny responsibility."

This whole lack of responsibility thing is a great way to stay right all the time. But it's a horrible way to manage a portfolio... or a life.

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