The year of the rat, redeemed

rat2The dozen animals that in order represent the birth emblems of the Chinese lunar calendar (respectively rat, ox, tiger, rabbit, dragon, snake, horse, sheep, monkey, rooster, dog, and pig) purportedly came about when the Chinese gods held a contest to determine their order. As the legend goes, the animals lined up on the bank of a river and were given the task of getting to the opposite shore. Their order in the calendar would be set by the order in which the animals managed to reach the other side.

The cat was afraid of water. The ox has poor eyesight. The calculating rat suggested that he and the cat jump onto the ox’s back and guide him across. Being shrewd, the rat shoved the unsuspecting cat into the water and jumped off the ox’s back just as he made it to shore, finishing the race first, garnering first position in the lunar calendar. The pig got last position, while the cat finished too late to win any place.

Certainly, many in the alternative investment industry can attest to be called rats last year (The Chinese Year of the Rat), and likely few were dubbed the moniker for being shrewd. But with the year of the ox shaping up to be an almost complete “V”-shaped financial markets recovery, perhaps a little rat-like perseverance-related redemption may be in the cards for managers.

This chart from Merrill Lynch’s latest “Hedge Fund Monitor” report shows just how clear that “V” shaped redemption may be. What the chart shows is that traditional long/short hedge funds have bounced right back to historically normal market exposure.

HF market exposure l-s Oct 2009 ML report

The question behind the “V” is whether the chart is more a sign of cat-like stupidity or even ox-like blindness. On one hand, most believe that hedge funds in general, long/short in particular, should have recovered from the 2008 crash alongside broader financial markets, which gained thanks to unprecedented stimulus and a variety of other factors. This half-year report covered last month by illustrated how resilient many hedge funds and strategies have been.

On the other hand, there is an argument to be made that the clear “V” formation prevalent in almost any charted returns is more reminiscent of “irrational exuberance” – a herd-like push into lesser-quality equities and instruments pushed forward by cheap leverage and the desire to get back above water in terms of lost performance fees and bonuses – and lost faith among investors.

A separate report released last week by search firm Heidrick & Struggles points firmly to the latter. The report, which details hedge fund search and recruiting trends as well as compensation activity, salary and bonus ranges, notes that hedge funds are now competing for talent with endowments, foundations, traditional asset managers, and asset management and proprietary trading desks of banks – the exact opposite of a year ago, when most hedge funds were laying employees off.

The one rat-like opposing fact: that despite talent wars, compensation is still down overall, and more fund closings are expected this year.

The jury is still out on what the true meaning of the year of the rat was. It is also still out on whether the rat has been redeemed, whether the ox will prove better, or whether there are still a nasty bunch of passengers riding the ox’s back.

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