How AMC Is Blowing Up the Hedge Fund Industry

Yesterday, high profile hedge fund White Square Capital announced plans to close down after big losses in GameStop. New York-based Mudrick Capital just took a massive loss on AMC. Melvin Capital is down by nearly half as AMC, GameStop and others continue to move against them.

These are not isolated events. There is a long term trend toward lower inflows to hedge funds:

This trend is much worse than it seems if you dig into the type of funds that bet against companies like AMC: long/short equity funds. They are the most common type of hedge fund, holding 28% of the industry’s assets.

But this strategy is dying. Long/short equity funds are seeing some of the largest outflows:

No wonder investors are losing patience: such funds have underperformed the market every year since 2011, often substantially:

Indeed, many long/short equity funds were shutting down even before 2021. I suspect those returns will be even worse this year, with high profile blowups in meme stocks.

If you’re a pension fund or college endowment, two types of institutions that often invest in hedge funds, why should you pay their high fees in return for such miserable performance? Hedge funds typically charge 2% of assets every year, plus 20% of any gains. What do I pay for my Vanguard S&P 500 index fund? 0.04% of assets every year, and not a dime of the gains.

Long/short equity funds aren’t providing much real value. What’s their strategy, to short stocks like AMC because they trade above their fundamental value? Everyone knows that. The Reddit crowd’s play is entirely technical: they hope to profit from a short squeeze or gamma squeeze.

Let’s compare this to another form of investing popular with pensions and endowments: venture capital. I invest in startups myself, so it’s a world I’m familiar with. What investors in startups do is entirely different from a long/short equity fund. We have to evaluate obscure, early stage companies with little publicly available information. We have to judge technologies most of the public hasn’t even heard of yet. And we aim to provide a lot more than money: investors often give advice and make key introductions.

Oh, and our money is locked up for about 10 years, versus easy liquidity in stock markets.

That said, even venture capitalists often fail to provide good returns. But here’s the approach I’d recommend for hedge fund investors:

1) Invest in hedge funds that have real performance and a strong value-add, and/or…

2) Invest in index funds, and/or…

3) Invest in something like venture capital, which can add real value

The hedge fund emperor has no clothes. And investors are beginning to wise up.

More on AMC:

Photo: “Fruit of the fireball machine” by SiamEye is licensed under CC BY-NC-ND 2.0

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