Why hedge fund performance is under pressure

Herding behavior by managers of hedge funds is just a special case of momentum investing. All market prices deviate from the 'real value' most of the time. The price discovery process at best is a process of approximation to value as new information is disseminated and digested by market participants. Technology and instant communication as well as low dealing costs and the enormous growth in pools of liquid capital exacerbate swings in the market - be they short-term (day trading, high-frequency trading) or longer term. The problem that hedge funds in particular face is that ultimately the only real returns that investments provide are either dividends or coupon payments. The rest of the profits from the investing game is redistributed wealth where one party wins what other market participants lose. This is particularly clear in the case of derivatives (futures, options, swaps etc). Profits from short selling are also always offset by losses on the part of long investors and redistributive by nature. As hedge funds concentrate on these type of redistributive trades they face a particularly strong headwind. The more crowded their space is, the tougher it is for them to create superior performance. This would have to be at the expense of other market participants. A fierce struggle between individual hedge funds to take a share of this diminishing cake can be likened to the fiery fight of a pack of wild animals for their share of prey.