By Linette Lopez From Business Insider

A bunch of hedge funds just sent a subtle message to the market: “Guys, we’re out of ideas.”

On Tuesday, the activist hedge fund ValueAct Capital announced that it had taken a $1.1 billion stake in Morgan Stanley. However, contrary to the “Act” in its name, the fund told The Wall Street Journal it had no plans to change much of the bank’s business, and the fund is instead convinced that the market has undervalued that business.

Fine.

On the same day, quarterly Securities and Exchange Commission filings revealed that Seth Klarman, the founder of Baupost Group, took a 5.2-million-share stake in Citigroup, worth $219 million. Leon Cooperman of Omega Advisors also added 828,000 shares to his fund’s position in Citigroup.

Across the board, large financials have had a horrible 2016. JPMorgan is doing the least badly, down only 0.82% since the start of this no-good year. Bank of America is hurting the most, down 11%. (Morgan Stanley comes in a close second, down 10.8%.)

What’s more, a lot of the conditions for the malaise in banking since the post-crisis era — things like low interest rates and onerous capital requirements — show no signs of abating. So why are funds buying in now?

Perhaps it’s a combination of running out of bright ideas and, worse yet, getting burned by the brightest ones.

Man, remember 2015?
Every fund mentioned above had a wretched 2015, and often because they picked stocks that screamed up the market and then crashed into near oblivion.

In ValueAct’s case, it was Valeant Pharmaceuticals, which has seen its stock price fall by about 90% since October, when accusations of malfeasance from a short seller and government scrutiny nearly destroyed the company.

Omega was a big investor in SunEdison, once the largest solar company in the world. Its stock started to collapse in July 2015, when the market sniffed out that the company might not have the cash to continue operations. SunEdison filed for bankruptcy this spring.

And then there’s Baupost, which in 2015 posted the third loss in its multidecade history. One of its biggest losers was Cheniere Energy, a stock it held through the second quarter of this year at least. The idea behind the position, of course, is that commodities prices have hit bottom. The problem is that they haven’t. While Cheniere is up 17% year to date, it’s still down 34% since this time last year.

All of these were big-idea plays. The idea that a company like Valeant could revolutionize healthcare by growing through acquisitions rather than through research and development made it a hedge fund darling. SunEdison’s complex business model and explosive growth also seduced Wall Street.

As for energy and commodities, who doesn’t want to think that the world is on its way to using its raw materials to grow and build again, regardless of contrarian data coming from emerging markets like China, South Africa, and Brazil?

Getting into financials is the opposite of this kind of thinking. It’s small, safe thinking in a market where stocks are looking increasingly expensive and opportunities are few.

Dude, boring

Since 2011, the banks have been boring. The fun proprietary equity trading stuff for double-digit returns of the pre-financial-crisis era is all gone, while interest rates are low, so fixed-income trading is a snore. Plus, the banks have to hold a bunch of capital that, in the bad old days, they would’ve been deploying to do this or that.

That isn’t to say there isn’t anything banks could do. Over at CLSA, analyst Mike Mayo has a long list of things that should happen to Morgan Stanley. It’s super inside-baseball stuff — buybacks and lowering regulatory costs and the like.

I won’t bore you, but the main takeaway is this:

“It has been four years since Morgan Stanley first mentioned its 10% ROE target (in its strategic presentation with 4Q12 results). Our estimates (and consensus) show that this will not get reached until 2018 versus 2016 previously. Although returns have improved, ongoing low core ROEs are unacceptable and below several peers. Nevertheless, here’s the important point: a 10% ROE in 2018 can be met largely through self-help, or factors that do not depend too much on the external environment.”

Of course, ValueAct isn’t talking about any of this anyway. In a letter to investors, CEO Jeff Ubben said: “There is a disproportionate amount of time and energy spent over analyzing Morgan Stanley’s trading and lending business and fretting about its Fed oversight. It feels like missing the forest for the trees.”

Oh, OK, so buy and hold then.

After all, the banks do pay dividends, and their stocks are pretty stable. If you want to put your money somewhere relatively safe in the market, this may be a decent play.

But, of course, hedge funds don’t get paid for “decent.” They get paid for amazing. On Wall Street, it’s called alpha, and stocks like Morgan Stanley and Citigroup don’t even come close to generating it. Without alpha, hedge funds can’t justify their fees; without fees, there really isn’t an industry.

Since the beginning of the year, even hedge fund masters like Steve Cohen of Point72 have warned that too many hedge funds are chasing too few ideas. Another investor, Dan Loeb of Third Point, spoke of a hedge fund “killing field” in April. There’s a connection there.

It would be a shame if Morgan Stanley’s 8% return on equity were the field this whole thing died on.

IMAGES:

Children walk past an installation shaped like “The Thinker” in Suwon, South Korea.Reuters

solar eclipse A student testing a self-made filter looks at the sun.Thomson Reuters

Jeff Ubben, the CEO of ValueAct.CNBC

For more on this story go to: http://www.businessinsider.com/hedge-funds-buy-citi-morgan-stanley-2016-8?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+businessinsider+%28Business+Insider%29