The Effects of the Economic Stimulus Act of 2008 on the Hedge Fund Industry

It’s been almost seven years since the enactment of the Economic Stimulus Act of 2008 (“the Act”), in which Congress provided several incentives intended to boost the U.S.  economy and avert a recession following the financial crisis that year. Hedge fund executives concur it benefitted the industry. It allowed stock markets to rise, which enabled them to generate positive performance for managers. Secondary to their steady returns, they argued that it gave banks the ability to generate a significant amount of capital and, finally, it fostered a decline in unemployment.

The economic stimulus caused prices to skyrocket. The result was twofold in the hedge fund space.

“For hedge fund managers such as myself, it uniformly sent our returns up and to the right,” said Steven Demmler, CIO of Palm Beach-based Demmler Investment Group, which manages a global long/short equity fund. “Second, for allocators and wealth managers, it made discerning the truly talented fund manager from those merely riding the colossal QE wave significantly more difficult.  QE made life easier for the fund manager. Post-QE will make it easier to weed out the pretenders.

Since the stimulus took effect, hedge funds have returned positive every year except 2011, a bad year due to fallout from the debt ceiling debate and fears of a European financial crisis). The Barclay Hedge Fund Index returned 23.74% in 2009, 10.88% in 2010, 8.25% in 2012 and 11.12% in 2013.

The Act also allowed financial assets to benefit with banks generating a significant amount of capital. William Ehrman, founder, Paix et Prospérité Funds, a New York-based global long/short equity manager, specified that the stimulus has had a positive effect for financial assets more so than the real economy.

“The banks and the Federal Reserve all created significant amounts of capital to use for consumer spending, mortgages, etc.,” he said. “However, that doesn’t mean the stimulus has been good for the real economy. If liquidity keeps increasing, it will never get its way into the system.”

The Act also fostered a decline in unemployment.  Daniel Schwartz, director of research at Argonaut Capital Management, a New York-based global macro investment manager, specified that economic stimulus has clearly been positive for the economy, as the combined impact of fiscal and monetary stimulus helped prevent it from falling into the abyss back in 2009.
 
“The effects of stimulus in more recent years, particularly the Fed’s now-complete program of bond purchases, are more controversial, but likely played some role in driving down the unemployment rate,” he said.

According to a Bureau of Labor Statistics report released at the beginning of October, the U.S. unemployment rate dipped below 6% for September, the lowest since July 2008.
 
However, Gary Brode, managing partner, Silver Arrow Capital, a New York-based value-oriented long/short equity manager, said while the underemployment rate decreased, some initiatives made it expensive to hire workers.
 
“The Affordable Care Act,  higher tax rates, more regulations and higher minimum wages have all made it more expensive to hire people,” he said.

Looking ahead, now that the economic stimulus is over, along with the fact that the Fed is expected to tighten its easy-money policies and raise interest rates, and finally, with volatility returning to the markets, hedge fund managers will experience more difficulties to outperform the markets and have greater challenges in navigating the choppy markets.