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I started this blog four years ago and my first post was about how hedge fund returns have been correlated with stock returns. That correlation hasn’t changed.

That’s because hedge funds and stocks are all part of the risk trade. Hedge funds take risks and so do stock investors. In the current environment where the market oscillates between “risk-on” and “risk-off”, it’s not unexpected that hedge funds returns be correlated with stock returns. The chart below shows the returns of the HFRX Global Hedge Fund Index, which is a representative index of all investable hedge funds, compared to the S+P 500.

Even though hedge fund returns were correlated to the S+P 500, the above chart shows that they tended to be less volatile than the S+P 500. What that means is that when stock returns are down, hedge fund returns should be counted on to be down less and beat stock returns. In 2011, the chart below shows that they didn't and lagged the S+P 500 instead.

A funny thing happened in 2011. First of all, hedge funds had a terrible year as they substantially underperformed the S+P 500. On a year-to-date basis to December 16, 2011, the HFRX Global Hedge Fund Index was down -9.0% after fees compared to -1.3% for the S+P 500.

The negative performance occurred across the board. The chart below shows the YTD returns of the various HFRX sub-indices. The Global Index was down 9.0%, but every single category of hedge fund returns underperformed the S&P 500.

The poor performance of hedge funds in all categories is illustrative of the headwinds faced by active managers in 2011. Nothing worked!

Two categories that performed particularly poorly were directional strategies, namely Market Directional and Equity Hedge, which allowed a manager to go long or short. Fundamental Value was the laggard at -23.6% for the year.

The carnage in hedge fund performance can be seen anecdotally from the headlines. John Paulson's Advantage Plus flagship fund's performance through December 16 is down -9% in December and -52% on a YTD basis. Legends like George Soros exited the business of managing money to focus on his own funds. I could go on, but you get the idea.

I am working on a much longer post analyzing why hedge funds performed so poorly in 2011. More on than later.

Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Source: A Terrible 2011 For Hedge Funds