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Putting Knowledge into Action

I have noticed a few articles just recently comparing the performance of hedge funds focused on energy and the rapidly rising price of crude oil. The Wall St. Journal had an article titled "Energy Hedge Funds Missing the Oil Boom" in part based on performance data published by HedgeFund.net. That website tracks 97 energy hedge funds and their performance and found that, on average, energy hedge fund performance was just around 4% through May as compared to oil-futures which are up more than 40% in 2008.

Now this is all well and good but its a tad unfair on energy hedge funds. No one in their right minds would pursue a long-only oil futures strategy. To do so may provide investors with a few months of amazing returns but it is equally likely that at any point those returns would dissapear overnight. It's simply a far too risky strategy in today's highly volatile oil markets.

In fact, the HedgeFund.net index isn't that representative. The 97 funds are treated on an equally weighted basis and represent all strategies including things like equity long/short, market neutral and so on. A far better estimate of hedge fund performance in the energy sector is provided by the Gardner Energy MacroIndex (GEMI). This index is a global investable, multi-strategy, sector hedge fund index that provides a macro view and enables broad exposure into the entire value chain and all sectors of international energy markets. Its performance reflects the performance of a group of established and emerging energy hedge fund managers who were selected based on objective criteria arranged in a proprietary selection matrix constituting between 35 and 50 components in the index at any given time. Year to date in 2008, the GEMI is actually down 1.18% confirming that energy hedge funds have had a hard time of it this year.

I think that there is at least one observation and a number of questions to be asked here. The observation is that, yet again, those that know little about energy investing and yet still blame this type of 'speculator' for the rise in energy prices should be quitened by the idea that the energy hedge funds are down in a year when oil and energy prices have risen so much. The questions all revolve around why are these funds performing poorly in 2008?

The answer to that question is not simple. The fact is that most energy hedge funds don't pursue a long-only, directional commodity trading strategy these days. Many now trade spreads - time spreads, product spreads, geographic spreads, and more besides. Many do not trade commodity futures at all and instead have seen their profits eroded by the general fall in equity markets this year and, some trade credit and distressed assets.... another problemmatic area.

Now, there are always exceptions to the rule and a number of funds have reported huge profits - largely commodity futures trading funds of course. But, while investors might be greedy they are also not always stupid and so they seek the real trading talent - the guys with a track record of producing returns over 3+ years and not those that happened to simply luck out this year...Their luck can always change.

It is a very complex issue as to why fund performance hasn't matched the performance of oil futures. Its a great story for the Wall St. Journal too. But the fact is its simply niaive to think that fund performance should track the oil price.