Long considered the titans of Wall Street, hedge fund managers have long thrived under a simple premise: They are smarter than the average investor and can produce bigger profits.
That image of the slick, well-connected trader, making bold bets with hundreds of millions of dollars, has attracted trillions from wealthy investors, pension funds and endowments who were willing to pay high fees and hand over 20 percent of any profits to the elite class of traders.
Now, though, many investors are reconsidering. Hedge funds produced returns of about 5?percent last year, according to Hedge Fund Research, compared with the 10?percent rise of the Standard & Poor’s 500-stock index, a broad collection of stocks that is trading near record highs.
Investors have responded accordingly, pulling $111?billion out of the industry in 2016, according to eVestment, an institutional investor data firm. More than 1,000 funds closed their doors last year, the largest number since the 2008 financial crisis.
Many of the advantages the industry relied on for decades have started to disappear, industry experts say. There are more hedge funds placing the same type of bets. And finding a unique idea, an undervalued company or one with flaws that no one else has spotted, is becoming more difficult, particularly at a time when so many stocks are rising, they say.
“The hedge fund industry has started to collapse on itself,” said Charles Geisst, a Wall Street historian at Manhattan College in New York. “There are too many players going after the same thing.”
Stocks limped across the finish line before the Memorial Day break, with technology stocks pushing the major indexes to new highs. The S&P 500 gained just 0.03 percent on Friday but it was enough to mark the seventh consecutive rise for the leading U.S. stock market benchmark.
That pretty much sums up the market dynamic of late: Small, consistent gains driven by a mere handful of mega-cap tech stocks. You know the names: Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google parent company Alphabet (GOOG), collectively known as the “FAANGs.”
The focus has become so intense it’s sucking the oxygen out of the rest of the market, causing investors to ignore some serious macroeconomic headwinds, and bringing back echoes of the late 1990s.
Consider, for instance, that while the major averages led by the Nasdaq Composite are pushing to new highs, broader measures such as the equal-weighted S&P 500 (which is less influenced by the FAANGs) have lagged, as shown in the chart of six-month price performance shown below. That’s not normal.
Nor is the narrowing focus on big-tech winners. Consider that just 68 percent of S&P 500 stocks are in uptrends right now vs. 80 percent back in March. Nor that tech insiders are aggressively selling their own shares. Nor that just five tech stocks have been responsible for 40 percent of the S&P 500’s market capitalization gains so far this year.
The scale of the tech surge is just breathtaking. Investor inflows into tech stocks is at a 15-year high. The market cap of many tech giants is greater than the economic output of many large cities, according to Bank of America Merrill Lynch, with Alphabet bigger than the GDP of Chicago and Amazon bigger than the GDP of Washington, D.C. And at $1.45 trillion, the combined market cap of Alphabet and Apple is larger than the combined market cap of all Eurozone and Japanese banks.