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Why The Smart Money Is Underperforming the Market: WSJ’s Zuckerman

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Hedge funds are having one of their worst performing years in over a decade. Bank of America Merrill Lynch reports that hedge funds are posting their smallest gains since 1997, and through the third quarter this year advanced just over 3% while the S&P 500 (GSPC) gained 13%.

The Wall Street Journal's Greg Zuckerman tells The Daily Ticker the underperformance is nothing new. Hedge funds and private equity funds have lagged the past few years but not to this extent, and both are now trying different strategies to reverse that trend, he says.

Related: Here Come the Chasing Hedge Funds

"The KKRs and Blackstones of the world are responding by going into other industries—lending money to hedge funds, building power plants and making big plays in real estate," says Zuckerman, adding that hedge funds can't by their nature diversify as much. The Carlyle Group (CG) recently bought a majority stake in commodities investment manager Vermillion Asset Management.

The problem, says Zuckerman, is that "hedge funds have grown too big and too bearish."

Assets have been pouring into hedge funds over the past few years from pension funds and other sinstitutional investors, and the funds are having a hard time putting all that money to work.

"They're not very good at managing so much money," says Zuckerman. "They're good at their first one through five best picks. After that they don't that well."

Related: Wall Street Analysts Give Hedge Funds the Inside Scoop: Scandal or Biz as Usual

Contrary to popular belief hedge funds are not necessarily designed to make big, aggressive bets on investments.

"They're suppposed to be more cautious and underperform in a market up 15%," says Zuckerman, but not by so much. Hedge funds have been "a little too skeptical, a little too suspicious of this rally."

Private equity funds are also having problems this year. Cambridge Associates says the biggest buyout funds launched in 2006 and managing $3.5 billion or more have gained just 4%.

Related: The New Tycoons: How Private Equity Owns the World

Zuckerman says private equity funds are stitting on close to one trillion dollars cash. That's not what investors had planned on, but Zuckerman says investors have been patient.

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