Hedge funds saw lousy performance last year... And this year, it looks like they're aiming for a repeat.
According to my contacts on Wall Street, the average hedge fund returned between 7% and 10% last year. And Hedge Fund Research recently reported that the average hedge fund was up 10.4% in 2019.
Either way, that's downright terrible performance. Remember, it's versus a total return of 31.5% for the S&P 500 Index.
The amazing part is, that was the best annual performance for the industry since 2009. But it wasn't enough to keep investors interested.
Massive underperformance led to asset outflows for hedge funds last year. In the fourth quarter, the industry is said to have lost $13.6 billion in assets. And outflows totaled nearly $100 billion for all of 2019.
Clearly, hedge funds are in a bad spot. When the best year in a decade is outright terrible and assets are rushing out, you know something's wrong.
But here's the crazy part. This year, it looks like hedge funds are aiming for a repeat.
Let me explain...
According to Bloomberg, prime brokerage data from Goldman Sachs indicates hedge funds are unloading their positions in technology stocks.
For anyone unfamiliar, prime brokers are an important part of the hedge-fund business. They are the custodian banks where these funds hold their assets. Goldman Sachs, UBS, and JPMorgan Chase are the largest players in the industry.
So, when one of them says hedge funds are unloading shares in technology stocks, it's significant. Especially considering how well technology stocks have performed in recent months...
Since the beginning of November, the iShares U.S. Technology Fund (IYW) has rallied 3.6% (including the latest pullback). And that's versus a fall of 4.3% for the S&P 500. That tells me the underperformance by hedge-fund managers is getting worse... not better.
Simply put, these asset managers have done well. But they're missing the boat. And getting out of technology seems like the worst option going forward.
Right now, we're living in a deflationary environment. At the least, we're in a low-growth, low-interest-rate environment.
If you're a business looking to make more money in this type of environment, you need to consider your investments carefully. You'll want to invest in something that expands your margins. That means investing in technology.
Upgrades to software and hardware should allow your company to run more efficiently and smoothly. It also means you need fewer man hours to conduct everyday processes. Not to mention that technology doesn't come to work hungover, doesn't show up late, can work for hours on end, and doesn't need medical coverage.
Businesses want more technology... not less. And it's not so different for investors.
As an investor, you also need to consider your investments carefully. Your No. 1 goal is to make money. And let's be honest – we all want to make as much of it as we possibly can each year. That way, next year, we'll have the opportunity to make even more.
That means that the current economic environment leans toward technology investing. It has been – and should continue to be – one of the best ways to make money in the stock market.
Hedge funds are missing out on that now. But here's the great part...
The longer all that money misses out on the returns, the more it's going to want to get back in. The information technology sector is the single best-performing sector in the S&P 500 over the past 12 months, with a 23% gain. The next closest is the communications-services sector at 9.2%.
At some point, those money managers will have to put assets back to work to get the performance they're looking for. And when they do, it will fuel further gains in the sector. Given that the sector has a 25% weighting in the S&P 500, that should also mean more gains for the broader market.
So hedge funds are selling tech. They're setting themselves up for another year of underperformance as a result. You don't have to make the same mistake, though...
I recommend you make technology a major part of your portfolio. It's the best way to profit in the current environment.
C. Scott Garliss
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