Highest Volatility in 50 years Spooks Hedge Fund Managers

Paulson loses $3 billion; dullest investments bring double-digit gains

Plain-vanilla bonds and widow-and-orphan utilities creamed hedge funds in 2011, offering fresh evidence that ordinary investors need not feel underprivileged for lack of access to more exclusive investment opportunities.

In a news release culling hedge fund data for 2011, Hennessee Group, which advises hedge fund investors, turned in a rather shameful report card for the funds, which target high-net-worth investors.

As a group, hedge funds experienced their worst year since 2008, losing 4.27% compared to a flat S&P 500 and a Dow advance of 5.52%, In contrast, categories favored by safety-conscious investors represented by the S&P/BG Cantor 7-10 Year Treasury Bond Index and the S&P North American Utilities Sector Index surged a 15.60% and 14.83%, respectively; conservative investments such as consumer staples and gold also outperformed.

Hennessee Group co-founder Charles Gradante suggests ordinary investors were not alone in the fear they felt over the markets’ high turbulence. “Hedge fund managers describe 2011 as ‘more frustrating than 2008,’ “ he said. “High levels of uncertainty and the highest daily average volatility in 50 years resulted in managers getting ‘whipsawed.’”

The Hennessee release adds that “managers entered the fourth quarter with low exposure levels in an effort to protect capital and were caught off guard by the double digit rally in equity markets.”

Like their mortal counterparts in mutual funds, the iconic managers of hedge funds appear to lack the omniscience often attributed to them in years when their clever bets yield triple-digit returns.

Hedge funds did beat the market in some sectors. The Hennessee International Index fell 6.39%, averting the fate left to investors loyal to the broad international MSCI EAFE Index, which declined 14.82%. Emerging markets hedge fund managers lost 12.85% compared to the benchmark’s 20.41% loss. But there was little to cheer hedge fund investors in 2011. The best-performing hedge fund sub-strategy for the year was the arbitrage/event-driven category, which lost 2.17%.

Investors in the Paulson & Co. hedge funds had an especially dismal year. Institutional Investor reports the company’s two leveraged funds, which account for most of its assets, lost 35.91% and 50.67% (except for a special gold class of those funds, which invests borrowed money in gold futures, and lost 22% and 35%, respectively).

John Paulson rose to fame in 2007, when he made $3.5 billion by shorting subprime mortgages. He gave most of that back last year, though, as Institutional Investor estimates his gold class investments decreased in value by $3 billion.

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