The world's largest listed hedge fund was one of the worst performers in 2009.
I'm not surprised investors are growing disenchanted with the funds offered by Man Group (LSE: EMG). As a shareholder in the hedge fund giant, my enchantment is wearing off, too.
I backed Man in the bear market, attracted by the low P/E, high dividend yield, strong balance sheet, and the sheer contrarianism of buying an investment manager when the sky was falling. I suggested Motley Fool readers might do the same last May.
Since then the shares have risen from 255p to 297p this morning -- a gain of 16.5%.
Not bad, except the FTSE 100 is up almost 30% over the same period. I'd hoped Man would outperform in a bull market, not bring up the rear.
True, the shares hit 371p in November, so gains of up to 45% were there for nimble traders. But such is the stuff of fantasy -- the reality is I'd thought Man was gearing up to soar with the recovery of risk appetite, and I clutched on. Since then it's been a steady slide down.
From hero to less than zero
Today's third-quarter update confirms what Man's sceptics suspected. Funds under management (FUM) at 31 December declined over the quarter to $42.4 billion, from $44 billion in late September.
The main cause was investors pulling $1.2 billion from Man's flagship AHL Diversified Futures fund. Man gives weekly updates on AHL's performance, so its poor December performance was plain for all to see, capping a grim 2009 that saw the AHL strategy lose nearly 26% according to Morningstar data -- its first ever annual loss.
And it's the performance of AHL that's critical to sentiment about the shares.
The AHL fund did extremely well in 2008, gaining over 70% in a year when most investors lost money. So why did it do so badly in 2009 -- a bonanza year for stock markets?
The answer is that the 'black box' software model that directs the $22 billion AHL fund seeks to follow trends in more than just equity markets -- it also follows commodities, bonds, and other securities.
I knew the fund was slow to catch the upturn in the stock market in Spring 2009, but according to Tim Wong, AHL's chief executive, it has also been hurt by a lack of clear trends in other asset classes.
December was a particularly bad month for funds driven by software models like AHL. According to BarclayHedge, which tracks hedge fund performance, most did badly, losing an average of 4.7%.
Mr Wong recently reassured AHL investors that 2009's performance was "commensurate with the types of drawdowns we have experienced in the past and within our statistical expectations".
In other words -- and feel free to swap in an expletive -- 'stuff happens'.
Soggy returns from software models
Normally a phrase such as the 'worst performance for two decades' sets a contrarian investor's tail wagging. The darkest moment comes before the dawn, and all that mettle-bolstering malarkey.
It's not like AHL's poor performance was an anomaly. Hedge funds that survived the 2008 meltdown generally had a great 2009, but most managed futures funds like AHL had a bad year. AHL's software model isn't broken, some would argue, it's the market that's been behaving oddly.
True, perhaps market conditions have fundamentally changed, and the investment conditions that were so profitable for these funds for the past couple of decades are gone forever.
Usually though, the best bet when investing is that it's NOT different this time. I therefore see no reason why AHL's performance can't improve in 2010 -- no guarantees, but I'd think modest gains are more likely than another unusually awful year.
The bad news is this might not be enough to help Man's profits, or its share price, in the short term.
Firstly, AHL's great 2008 and its subsequent decline means the fund is currently well down on the level where Man will collect juicy performance fees. Given that AHL represents more than half of Man's FUM, that's going to seriously impact on profits.
Worse, AHL's bad 2009 outing is going to make it a very difficult sell in 2010. Value investors may see a depressed fund poised to revert to the mean, but the sort of people who invest in managed futures do so precisely because they don't want to see negative years.
Morgan Stanley said as much earlier this week, cutting its price target from 400p to 340p on just these concerns.
The trend is Man's friend
Today's update wasn't all bad. FUM were down by 4%, as mentioned, but sales to private investors in the quarter of $1.1 billion helped make up for the $1.4 billion in institutional redemptions. And Peter Clarke, Man's chief executive, revealed a new mandate with a pension provider that could add $1 billion to Man's FUM.
Indeed, Clarke sounds quite bullish:
"With a promising outlook for hedge fund flows and significant recent progress in our managed account business, Man remains very well placed to grow assets."
The market isn't convinced -- despite most of today's news not being very new thanks to the public reporting of AHL's returns, the shares are down over 5%.
At 297p, Man is on a trailing P/E of around 6, but this spikes to nearer 18 for the year to March 2010, as the consensus among analysts is for a 50% fall in earnings. That would leave Man's very attractive 8.8% dividend yield uncovered, though the company has the cash to stave off a severe lop in March, should it choose to. Any strengthening in the pound versus the dollar would also threaten the dividend.
The AHL fund has started the year better than it ended the last, rising 1.9% last week. Investors in Man shares had best hope the black box's new year resolution is the start of a trend towards a better 2010.
More from Owain Bennallack:
Owain owns shares in Man Group.
