Are hedge funds suffering a crisis of faith? Fund managers have moved money out of the market to record-high cash levels, leverage is historically low, and few managers have figured out how to profit from the wild swings in the market. It might seem counterintuitive that hedge fund managers have become so risk averse. But performance was sluggish this year even before the markets turned violent in August. Then, in what seemed like a perfect environment for players known for their prescient market calls—not to mention their ability to short—one might have expected them to rebound. Instead, the losses started to mount.
With the experiences of 2008 still fresh, many managers are finding few trades where their conviction is strong. The stock market is difficult to time because of today’s rampant volatility. With interest rates so low, fixed-income markets are almost played out,...