Not long ago it seemed that the "smart money" was invested in hedge funds which generated outsized returns for investors. When broad markets fell by 40% in the crash of 2008 and 2009, hedgies like John Paulson, who bet against mortgage-backed securities, made fortunes. In 2007, Paulson made $3.7 billion. In 2010, he made $5 billion.
Now that the financial crisis has abated, such returns for Paulson and his fellow superstar hedgies appear to be a thing of the past. And, with the recent rash of insider trading prosecutions by the Feds against hedge fund managers, investors must seriously question the value of putting their money with these folks.
The saga of SAC Capital may ultimately show that the only reason hedge funds realized outside returns was through illegal insider trading on confidential information. And the bad news around SAC and its manager, Steve Cohen, continued to get worse over the past week.
Investors are waking up to the fact that the former hedge fund emperor Cohen truly has no clothes, and that could spell a disaster for the $2.3-trillion industry.
Now, investors want out - desperately, it seems - from Cohen's funds.
The New York Post's Kaja Whitehouse on Tuesday reported that a group of investors wants Cohen and SAC Capital "to fork over nearly $1 billion - cash the hedge fund giant earned by trading on alleged inside information of drug company Elan Corp. Remember, SAC settled earlier this year with the Securities and Exchange Commission for $602 million for such alleged insider trading.
And according to a report in Friday's New York Times by Peter Lattman, Cohen is "fighting to keep" clients. Cohen must be pining for days past, when he turned new business away.
The tarnishing of other rock star hedge fund managers such as Bill Ackman, who made the disastrous pick of J.C. Penney (NYSE:JCP), shows that the bloom is officially off the rose with these fund managers.
So what have hedge fund investors been receiving for their payment of 2% of assets and 20% of returns? The answer is subpar investments. A new study shows that in the past year, hedge funds increased 6.2% compared with 13.4% gain for the S&P 500 Index, according to David Weidner of MarketWatch. This year is no better with the hedge funds doing about 5% for the first quarter of 2013 compared to a 10% gain for the S&P 500 Index.
So how do the hedge funds pick up the pace? Will hedgies more and more rely on insider trading? Will they show up more and more on CNBC and other news outlets to hype stocks? Or will today's old Masters of the Universe simply disappear like the thousand hedge funds that have closed their doors over the past 3 years?
Hedge fund investors beware, the "smart money" ain't so smart anymore. In fact, it's looking kind of dumb.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.