The 2020 Survey of the Top 50 Hedge Funds
Commissioned by SALT and written by Eric Uhlfelder
HEDGE FUND INVESTING DURING THE TIME OF COVID-19
The value of this year’s annual hedge fund performance survey through December 2019 was ostensibly turned on its head when a pandemic virtually shut down the global economy and sent securities plummeting during the first quarter of 2020. But a deeper look at these consistently performing funds revealed managers that as a group have largely been able to weather the storm better than the market and their peers.
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Sometime in late February, the world changed, leaving most market observers to believe more than ever that past fund performance should be considered just that.
While the Coronavirus stopped much of the global economy in its tracks, it hasn’t infected the skill set of many proven hedge fund managers. That’s one of the key findings of this year’s annual hedge fund survey.1
The venerable $30 billion hedge fund shop Citadel has a record of generating impressive returns especially when markets make sharp turns by consistently concentrating on risk and recalibrating exposure in step with anticipated changes in underlying conditions.
It did so when the markets suddenly turned south in the fourth quarter of 2018. It quickly pivoted to profit during the strong rally in 2019. And the firm was mindful of a potential major market shift going into 2020 before the pandemic struck. This enabled three of Citadel’s funds to qualify for inclusion in this year’s survey.
Eric Costa, global head of hedge funds at the consultancy Cambridge Associates, believes there are discernable qualities that will give fundamental equity and credit managers a performance edge, especially in extraordinary times. These traits, reflected in past performance, include:
- Consistent long-term performance and volatility that reflects a repeatable investment process, a clear commitment to a particular style, and a long-term investment horizon;
- Alignment of manager and investors interests, including managerial and portfolio transparency; and
- Stability of client base.
This study identifies 50 of the top long-term performing hedge funds, running broad strategies with at least $300 million, ranked according to their trailing five-year net returns through 2019. Also included are these funds’ net returns for the first quarter of 2020 to capture the initial response caused by the Covid-19 shutdown.
The main takeaway: Managers’ ability to have delivered consistent substantial performance while having effectively managed risk over the past five years through 2019 has not only enabled them to collectively track the S&P 500’s returns, but has done so with less risk. And during the first quarter of 2020, this same group of well-established managers—some industry leaders, others little known--outperformed the stock market and the hedge fund industry by a wide margin.
This doesn’t surprise Panayiotis Lambropoulos, a hedge fund portfolio manager at the $28 billion pension fund--the Employee Retirement System of Texas. He sees a clear link between managers who don’t jump on hot trends and those who don’t get crushed during a crisis. Echoing Eric Costa's sentiment, Mr. Lambropoulos believes, “Managers who stay faithful to a proven, disciplined, risk-centric investment strategy to generate consistent returns often have the ability to respond to a sudden drastic shock.”
Rather than giving managers a mulligan for the first quarter during this unprecedented crisis, Lambropoulos thinks allocators should hold managers accountable for their performance, seeing merit in Mike Tyson’s quip: “Everyone has a plan until they get punched in the mouth.”
The survey’s key findings:
- The average 5-year annualized net return through December 2019 of these 50 funds was 11.26%--more than 7 percentage points a year greater than the hedge fund industry average return;
- The S&P 500 Total Return Index (without any expenses) generated 11.70% a year over the same period. And this included the market’s extraordinary 2019 performance when the Index soared 31.5%, far outpacing virtually all active managers mindful that 2019 was the tenth year of a bull market;
- Not only did the survey’s 50 funds’ returns virtually match the market over the past 5 years, they did so with an average annual standard deviation of 7.80% versus the market’s 11.88%;
- Their average worst drawdown over the same period was -9.1% versus -13.56% for the market; and,
- And the group's average 5-year annual Sharpe Ratio was 1.84 versus the market's 0.89.
During the first three months of 2020 as global economic activity collapsed, the S&P 500 lost nearly -20%. The average return of the hedge fund industry declined by more than -11%, according to industry data provided Backstop BarclayHedge (BBH). The average return of the funds that made this year’s list lost -7.75%.
While markets have made a substantial recovery from their March lows, it’s still too early into the crisis to have certainty about what equities, credit, and hedge funds will do for the rest of 2020 and into 2021, says veteran economist and former senior partner at Solomon Brothers Henry Kaufman. He believes there will be a widespread destruction of capital across many sectors, and the appetite for risk, which was healthy entering 2020, will be broadly ratcheted back as businesses and consumers cautiously weigh back into markets.
“Despite the current market euphoria,” posits Kaufman, “until much of the US and major global markets have been inoculated with a proven vaccine to Covid-19, economies will be operating in an evolving new normal that broadly cannot support the market valuations at which we entered the crisis and which the market is attempting to revisit in June.” Kaufman believes successfully navigating this unexplored financial territory is the challenge facing fund managers and investors for the next several years.
But what’s evident so far, according to Päivi Riutta-Nykvist, a veteran alternative investment allocator at the €6.6 billion Helsinki-based FIM Asset Management, which serves institutional investors, family offices, and high-net worth investors, “is that proven, well-experienced hedge fund managers will have a much greater ability to respond to the current turbulence than most other asset-class managers. These include those running mutual, exchange-traded, real estate, and private equity funds, whose portfolios and market positioning are largely locked in place.
As the bull market charged into its 10th year, the $3 trillion hedge fund industry was thrashed for repeatedly trailing equities while collecting hefty fees in the process.
This performance gap was hard to argue with and has begun to affect industry asset count.
Over the past 12 months through March 2020, BBH reported net outflows of $159 billion out of hedge funds. Coupled with trading-related losses of $143 billion, global hedge fund assets have fallen from over $3.01 trillion to $2.86 trillion at the end of March. This was the first time the industry lost net assets since 2008.
Adding in assets of Commodity Trading Advisors pushes the current industry count above $3 trillion. But this flow reversal indicates a paradoxical break in sentiment.
Hedge fund assets had been steadily climbing over the past two decades due to an increasing institutionalized client base. This shift, away from an industry dominated by more aggressively minded high-net worth and family office investors, took off after funds profited during the 2001 to 2002 Tech Wreck and accelerated when hedged equity managers contained losses to less than one-third of the market’s
-37% collapse in 2008.
This shift in investor base to more conservative pension, endowment, foundation, and insurance company investors, whose focus is more on capital preservation and absolute returns rather than beating the S&P 500, has generally turned hedge fund managers more defensive. This has brought criticism to the industry as the fortunes of low-cost indices have soared.
While it’s too early to tell how hedge fund managers will fare by the time Coronavirus fears recedes, their first quarter returns, on average, have shown an industry that has mitigated losses when the global economy shut down. The market collapsed by -20%; the average hedge fund lost less than -12%.
That said, Russell Barlow, Global Head of Alternative Investment Strategies at $670 billion UK-based asset manager Aberdeen Standard, whose hedge fund exposure declined by just 3% in the first quarter, still believes there’s a world of difference between managers who are being judiciously defensive and those that are weak.
Herein lies a fundamental problem with the hedge fund industry: there are too many mediocre to poor managers as evidenced in a recent historical performance survey of 20 leading strategies, which incorporates the returns of 1000s of funds.
Hedge funds across all strategies provided by BBH have generated annualized returns of only 4.2% between 2015 and 2019 while the S&P 500 Total Return Index has increased by 11.70% annually. And over the past decade, hedge funds have done little better, up 4.77%, while stocks have increased by more than 13.5%.
As the table below indicates, dispersion of annualized strategy returns over the past 5 years was narrow. Commodity Trading Advisors, which bet on broad market trends, and Volatility Traders, who try to profit by anticipating pronounced market shifts, performed the worst, having lost an average of -0.05% and -0.48%, respectively.
Where traditional debt and equity indices did fairly well over this period, hedge fund managers who focused on credit and stocks generated only modest returns. Credit Long/Short managers returned only 2.82% a year, Credit Long-Only funds were up 2.93%, Equity Long/Short funds gained 3.17%, and even Equity Long-Bias managers were only able to gain an average of 4.50%.
The most compelling strategy, measured by positive consistency before and after the Coronavirus struck has been Asset-Backed Loans—managers who initiate and hold debt-like investments collateralized by various assets.
Between 2015 and 2019, ABL was the top-performing strategy, returning annualized gains of 6.76%. And during the first three months of 2020, the 50+ ABL managers that reported to BBH did a good job preserving capital, having lost on average just -2.5%.
However, Jonathan Kanterman, a managing director at the former $1 billion ABL shop Stillwater Capital, cautions that while the strategy has held up so far during the crisis through March, he’s concerned what this performance data may not be showing. “Some of these numbers,” explains Mr. Kanterman, “may be based on prepaid or accrued interest—not cash currently being received.”
In addition to uncertainty about future payment flows, he says fund performance may be hurt by declining valuation of underlying collateral and the negative impact leverage might have on funds who use it to enhance returns. “If current market conditions worsen or fail to revive,” says Mr. Kanterman, “then these risks could produce significant fund losses across the space.”
“What these and all other strategy performance numbers tell us,” adds Mr. Kanterman, “is that effective, long-term investing in hedge funds is not just in selecting a balance of strategies that correlate well together, but in identifying managers who have shown a consistent ability to deliver significant material returns across full market cycles, including periods of unexpected shocks, which reveals a robust focus on risk management.”
Structured Credit may be one strategy that proves to be an exception to this approach.
Managers focused on Mortgage-Backed Securities, Asset-Backed Securities, and Collateralized Debt Obligations--financially engineered vehicles that seek to capture interest flows across various types of debt--have enjoyed solid long-term performance over the past decade through 2019. But their returns have turned sharply south during the first quarter of 2020. And at this point it’s difficult to know if their underlying assets have been materially impaired and how long they may need to recover.
Structured Credit aside, most funds that qualified for inclusion in this year’s survey, especially those launched more than a decade ago, have demonstrated a history of generating consistent returns, which may help explain why as a group they not only tracked the performance of the broad market over the last five years with less risk, but have done a superior job preserving capital during the first quarter of the Covid-19 era.
The 50 funds that made this survey are not reflective of the hedge fund industry. They are outliers, revealing the industry’s promise.
They have defied the averages. Their mean age is nearly 12 years—more than twice as long as the life expectancy of the average fund. Their returns have collectively kept up with a raging bull market while exposing investors to less risk.
Use of performance hurdles raised the threshold for making and enhancing the quality of funds on this list.
This was initiated in last year’s survey I prepared for The Wall Street Journal, which tracked performance over a trailing five-year period through 2018.2 Because 2018 was the first year in nearly a decade when the market had lost money, setting a performance hurdle of 5% for that year was a basic way to see which funds delivered some form of alpha—swimming on their own without support of a buoyant market. Paraphrasing Warren Buffett, the hurdle helped reveal which swimmers had shorts on when the tide went out in 2018.
That hurdle was maintained in this survey for 2018 as well as for 2019. The latter was imposed for several reasons. One, regardless of past performance, it eliminated funds that ducked for cover after the 4th quarter 2018 stock selloff and failed to pivot back into the historic 2019 rally.
Two, and even more basic, requiring only several hundred basis points of returns above the risk-free interest rate seemed modest for any manager collecting management and performance fees.
Three, requiring funds to have back-to-back years of positive gains in 2018 and 2019 while generating the best trailing five-year returns helps this survey to highlight managers ability to generate consistent absolute returns while containing downside risk.
And four, while not appearing to be a demanding performance threshold, it recognizes the fortunes of many strategies are not tied to a roaring stock market.
This is an essential point that many industry pundits fail to understand.
Strategies such as Credit, Equity Market Neutral, and Global Macro funds are designed to generate returns independent of what stocks are doing. Expecting them to do otherwise would contradict the diversification they seek to provide investors.
This point is borne out by the collectively low correlation of the survey’s 50 funds to the S&P 500: 0.20.
In his search for consistent absolute returns, Tilo Wendorff, managing director of absolute returns at the €16 billion German alternative investment manager Prime Capital, targets managers that:
- Focus on Alpha (returns independent of the market) rather than Beta (market risk);
- Do not chase trends;
- Have low, stable net exposure that typically ranges between 5% and 15%;
- Are inherently risk adverse;
- Have a proven track record, including experience successfully managing risk during a major crisis; and
- Have shown the ability to repeat a proven investment process.
These traits helped his €1.5 billion hedge fund exposure to limit first quarter losses to -5.0%, well less than half the average hedge fund loss and superior to the HFRI Fund of Funds Composite returns of -7.6%.
While strategy-level performance may provide some guide to what funds have done, Mr. Wendorff knows average numbers don’t reveal the outlying talent that’s out there.
Equity Market Neutral
About one quarter of Mr. Wendorff’s hedge fund exposure is in Equity Market-Neutral funds—a strategy that limits net exposure between -20% and +20% to help capture positive returns that are then often enhanced with leverage. The 114 Equity Market-Neutral funds tracked by BBH generated little gain over the last five years through 2019. But over the same period, these funds helped Mr. Wendorff generate nearly 9% annual returns.
Only one Equity Market Neutral fund made this year’s survey. Toronto-based Anson Investments Master (No. 49) generated 11.7% annualized since its inception nearly 13 years ago. During the first quarter of 2020, the fund lost -4.30%. It cut losses slightly to 3% by the end of May.
This $378 million fund, which invests primarily in micro- and small-cap equities, focuses on absolute returns, according to co-portfolio managers Moez Kassam and Amin Nathoo. “Our shorts are opportunistic investments,” explains Mr. Nathoo, “not hedges, which helps our balanced exposure to perform consistently, especially during a crisis. Anson’s annual volatility historically has been running several percentage points less than the market.
Mr. Kassam is cautious about the current market rally. He believes that “when the exuberance of government stimulus has waned, the problems that had troubled many companies will become quite evident as investors begin to more accurately assess valuations.” He expects this to generate compelling short opportunities.”
On the long side, the fund believes the crisis will provide an opportunity for attractive entry into new financing—in the form of secondary stock and convertible debt offerings with compelling terms.
With the managers believing a second wave of the Coronavirus likely to hit, accompanying with enhanced market turbulence, they think the most difficult challenge is trying to estimate future consumer demand and corporate investment. “This makes due diligence that assesses the underlying strength and weaknesses of companies more critical than ever,” explains Mr. Nathoo, “as well as the ability to rotate quickly out of mistakes.”
Smaller funds like Anson have a much easier time making such sudden course corrections than most multi-billion dollar funds, revealing another key finding of the survey.
Large shops including Renaissance, Element Capital, and Citadel are top consistent performers. But annual historical surveys reveal a high percentage of funds that make the cut are on the smaller side.
ERS Texas PM Mr. Lambropoulos believes “in the merit of proven, smaller, institutional-caliber managers to help him potentially achieve long-term investment goals.” His pension fund has teamed up with the fund of funds manager PAAMCO-Prisma to underwrite small, emerging managers to help boost returns.
“Because of their size,” explains Cambridge’s Eric Costa, “smaller managers have the ability to invest meaningfully across a wider universe, compared with larger peers, and move in and out of positions more nimbly, without impacting prices.”
Perhaps it’s not so surprising to find 8 of the top 10 funds in this year’s survey were running less than $900 million. Nearly half the funds on the list were managing under $750 million; 15 were running less than $500 million.
Another small shop: the $500 million Millstreet Capital was the top-performing Credit Long/Short fund (No. 6) in this year’s survey. Not only did the fund limit first quarter 2020 losses to less than 4.4%, but managers Craig Kelleher and Brian Connolly believe the worst may be over for select non-investment-grade credits.
Millstreet has been generating annualized returns of 10.8% since it launched its high-yield credit fund a decade ago through 2019. After Covid-19 struck, the managers are seeing increased opportunity in the under-researched space of small- to-mid-cap firms, which contributes to trading inefficiencies. The firm’s net long exposure has moved up from 52% to 63%, and the managers expect it to inch higher.
In not mincing words, Mr. Kelleher projects “the next couple of quarters will be ugly as companies burn through cash, credit metrics deteriorate, and defaults rise.” But he also sees substantial mispricing, creating short opportunities for firms he thinks will tank and long buys for firms he believes will survive—such as grocery chains and delivery services.
Keys to the firm’s credit selection include identification of companies with clear liquidation value, stock price that trades at an exceeding low earnings multiple, a long runway that will allow a firm to stay in business over the next year, access to credit, and a relatively low Debt/EBITDA ratio, and stronger cash positions compared to the rest of the high-yield industry.
The managers have preserved capital by largely investing in first-lien senior-secured credits, avoiding companies with substantial debt, hedging materially long individual or sector positions, focusing on fundamental issues that may reveal risk before financials do, and avoiding making decisions based on emotion, especially when there may be an innate urge to do so.
Equity Long Bias3
The top-spot of the survey was claimed by another small fund—the $510 million Equity Long-Bias Sosin Partners, which generated annualized returns of more than 33% since its launch in fall of 2013 through 2019.
Managed by Clifford Sosin, the fund is a throw back to the way many hedge funds used to be run prior to the 21st-century wave of institutionalization that throttled back industry risk and returns.
In keeping with this swash-buckling spirit, Mr. Sossin searches out companies with creative business plans, digging into their operations and finances, then concentrating a large portion of his book into his favorite names.
Carvana, the online used-car sales portal, and Cardlytics, the direct advertising vehicle channeled primarily through bank websites, made up 70% of Mr. Sosin’s positions before Covid-19 struck.
He refrains from using hedges or shorts to counter volatility, believing the most essential part of his risk management is in stock selection. More so than any manager interviewed for this survey, Mr. Sosin’s deep investment convictions also extends to belief in the essential soundness of our government and economy.
“Consumers will go back to work and government will adequately fill in the gap caused by the shut down, and production will recover,” predicts Mr. Sosin. “I believe what we are seeing is only the temporary idling of our country’s capacity.”
He believes his two largest positions “will not only survive this shutdown but come out ahead of their respective competitors because of the strength of their balance sheets and business strategies.”
Guided by such certainty in his calls, it’s not surprising that while generating top returns over the last five years through 2019, Mr. Sosin had one of the worst draw downs over that time: -24.6%. This is a vulnerability of Equity Long-Bias funds.
During the first quarter of 2020, Sosin Partners got hit more severely than any other fund in this survey, having lost more than 44%. By the end of May, the fund had rallied back into the black.
Despite the strategy average having declined by nearly 9% in the first quarter, Reuters reported a breakout for some Multistrategy managers. It found a number of these funds, which “bet on a broad array of markets using teams of traders, leverage and centralized risk management, have flourished as stocks ended their worst three months since the 2008 financial crisis.”
As their name suggests, Multistrategy funds integrate various strategies to ensure access to opportunity across market cycles.
The annualized returns of the 164 Multistrategy funds reporting to BBH over the past five years through 2019 suggest funds are running strategies that are cancelling each other out, having generated just 2.3%.
But this year’s survey shows seven outliers that collectively have registered 5-year trailing returns of 11.73%. And their average first quarter loss was -1.14%. Leading performers included the $20 billion Citadel Wellington (No. 12), the $14 billion D.E. Shaw Composite (No. 24), and the $3.7 billion Hong Kong-based Segantii Asia-Pacific Equity Multistrategy fund (No.13).
Segantii preserved capital during one of the worst economic downturns, according to partners Simon Sadler and Kurt Ersoy, by staying consistent with an investment approach that was established more than a decade ago. It was up 30 basis points through the first quarter of 2020.
The fund has delivered annualized returns of better than 14% since its launch over a dozen yeas ago by focusing on liquidity, net exposure, and most importantly, responding quickly to material market changes as it moves in and out of its Event Driven and Relative Value investments.
What gave the partners confidence to make rapid decisions was having worked in Hong Kong through various crises, starting with when SARS struck in 2003. And last year, they dealt with the growing risks associated with widespread political protests across Hong Kong—which have again flared back up. “We’ve been in crisis mode for quite some time,” observes Mr. Ersoy.
In late February 2020, the partners read clear signs the virus, which had exploded in Hubei Province in China, was beginning to morph across global markets. “We saw spreads widening to crisis levels in merger arbitrage and relative value trades,” noted Mr. Ersoy. The US VIX also shot up to 40, something it had only previously done a few times since the 2008 Global Financial Crisis, as option valuations begin blowing out. “The velocity and the degree of change are why we thought risk was blinking red,” recalls Mr. Sadler.
Segantii began shifting its portfolio into a more defensive posture in early March. By month’s end, it saw sentiment again changing and began employing more risk. This helped Segantii end the quarter in the black. Through the end of May, the fund was up 4.25% for the year.
Knowing when to ratchet back risk and when to shift back into it are essential managerial qualities, says Prime Capital’s Tilo Wendorff. Specifically, he wants to “see a fund identify specific thresholds that will trigger a reduction in portfolio risk when events call for it and a corresponding set of parameters that will trigger a Risk-On response when increased exposure is in order.”
The most telling example of the risks investors can face when over-concentrating on a single strategy, even one that has delivered a consistent long-term track record, has been borne out (so far) by structured credit.
These are financially engineered investment vehicles that look to generate steady income from various sources of debt, including Asset-Backed Securities, Mortgage-Backed Securities, and Collateralized Debt and Loan Obligations. And until this year, many such funds have delivered on their promise.
In both last year’s Wall Street Journal Survey (data through 2018) and this year’s survey, structured credit funds were the most prevalent strategies by fund count. So far through March, the funds that made this year’s survey lost around one-quarter of their value.
As widely reported, structured credit funds were the most severely stung by Covid-19, because of anticipated impairment on interest payment flows and valuation of underlying assets. Most managers were also hurt because they do not meaningfully hedge their exposure, believing in their strategies’ inherent stability. “It will take time,” Mr. Kanterman says, “to assess how deep or recoverable the damage has been.”
Kai Rimpi, head of hedge fund allocation at €47 billion Helsinki-based Varma Mutual Pension Insurance Company, saw this damage close up.
For 18 years, Varma has been generating average gains of close to 7%. It’s €9 billion hedge fund exposure has been a significant contributor to the firm’s consistent returns, explains Mr. Rimpi.
While diversified across its core US-based Multistrategy, Global Macro, Fixed-Income Relative Value, and Equity Market-Neutral funds, Mr. Rimpi’s largest strategy exposure is Opportunistic Credit and US Residential Mortgages. They have generated a fairly steady annual return stream of 10% over the last decade, until 2020.
They lost -15% during the first quarter of the year, which brought down his net hedge fund loss year-to-date through March to nearly -12%.
He explains, “March was a very tough month for various asset classes, especially for credit, which was hurt by a sharp sell off by money market funds meeting redemptions and public REITS deleveraging to meet margin calls.” The resulting collapse in meaningful pricing of credit led to REIT liquidations, which fueled the sharp decline in marked-to-market numbers.
“It was kind of a self-reinforcing cycle,” observes Mr. Rimpi, “which seems to have come to a stop.” While he doesn’t expect a quick rebound in Opportunistic Credit and Residential Mortgages, he thinks pricing may recover over the next 12 months.
Despite significant exposure to Structured Credit, Aberdeen Standards’ $14 billion hedge fund book held up, down 3%.
The reason, explains Mr. Barlow, the firm’s global head of alternative investment strategies, is due to balanced weighting across all its strategies, which include Relative Value, Distressed Securities, and Credit Long/Short funds. Performance of these three strategies were collectively neutral during the first quarter.
Another reason for having sidestepped major losses, explains Mr. Barlow, is that “we don’t diversify across dozens of managers but focus about two-thirds of our exposure to just 10 managers in which we have strong convictions.” Limited manager exposure, he explains, is key to being able to thoroughly understand each fund, monitor its behavior, and manage risk to help ensure quality long-term performance across market cycles.
Having seen substantial price dislocation across Residential Mortgage-Backed Securities, Collateralized Loan Obligations, and Levered Loans, Mr. Barlow is selectively increasing his exposure to Structured Credit.
While he believes the market may retest its March lows, Mr. Barlow is cautiously optimistic based on broad sentiment that the market has bottomed, the US Federal Reserve Bank throwing everything at the crisis, and the speed and magnitude in which the Federal Government has responded with stimulus packages.
Managers that seek material exposure in troubled companies to turn them around may be seeing a shopping cart of opportunities as businesses try to restart. But many of their open positions likely took a sharp hit, having suffered worse than the market.
For Legion Partners (No. 27), it was a perfect storm because not only is it invested in companies in need of operational improvement, they target small-cap firms that are more volatile than large companies, and they run a concentrated book of less than a dozen core positions—leaving them no place to hide.
The $354 million Los Angeles-based small-cap activist fund, managed by David Katz and Ted White, which had been churning out 10% annual gains over the last 5 years through 2019, lost about a third of its value in the first quarter of 2020. By the end of May, it had cut year-to-date losses to 11.5%.
The managers’ early response to the crisis was to sell a main position that was in an industry they don’t expect to recover very quickly and to reinvest in a food distribution firm in which it had already successfully cashed out. With its share price having crashed 90%, Legion’s co-founder Ted White saw an opportunity in a shop he already knew well.
Legion also moved into a new communication/infrastructure firm that the managers believe should execute well in a Covid-19 restricted environment and beyond. “About half our core investments are in businesses that should thrive during lock-down and economic uncertainty,” explains White.
The sudden market crash did indeed create a host of potential buying opportunities across the 700 companies Legion tracks. The problem: many of these companies also saw their potential target values recalibrated downwards. And herein lies the challenge of identifying truly deep value opportunities during a pandemic, explains White.
Many assumptions must be made in estimating forward valuations. With the constant flood of data and opinions about how the crisis will further unfold, White admits it’s difficult to distinguish between accurate signals versus noise. He feels “one can’t even be particularly certain how the rest of the year will play out.”
That’s pretty much the challenge facing managers of all strategies.
Running a concentrated book, however, enables Legion to better focus on its few investments than managers running much larger portfolios. This helps White’s team to be far more certain about which companies can maintain sufficient liquidity and access to capital to survive the lock down and additional waves of the pandemic with business plans that can be expected to thrive regardless of an uncertain future.
TRYING TO LOOK AHEAD
As the SS&C GlobeOp Forward Redemption Indicator graph shows (below), hedge fund investors have largely stayed on board. The graph doesn’t even register any kind of event having occurred this year. As the world’s largest hedge fund administrator, its trends may be a legitimate proxy for the industry.
To Jim Ramenda, head of risk analytics at SS&C Technologies, the administrator’s parent company, he surmises the steadiness in both redemption and net asset flows may be reflective of lessons learned by institutional investors and hedge fund managers from panic selling during the Great Recession that’s helping both to more calmly navigate the crisis.
Limited redemptions doesn’t surprise Cambridge’s Eric Costa, who notes there has been less than a dozen notable fund closures during the first four months of the year and doesn’t expect that number to materially increase.
“Managers as a whole have responded reasonably to the shock,” observed Mr. Costa, “served well by their increasingly defensive positioning over recent years, and quick and aggressive government response. This has tempered initial fears of a systemic market collapse far more effectively than the government’s much slower reaction to the Great Recession.
But such optimism doesn’t indicate allocators are ready to turn on the pre-crisis financial spigots.
“While most institutional investors have been pleased by how their hedge fund investments have performed,” observes Mr. Costa, “over the near term, the majority will take ‘a wait and see’ approach.” Knowing there will be permanent damage to major industries, allocators will encourage many investors to keep their powder dry until there is clarity about the how well the economy is mending.
FIM’s Riutta-Nykvist cautions that most managers who are currently seeing their portfolios rebound will take it as proof central banks will protect their investments. But it’s the small minority of managers who see passed the government-sponsored rally that she believes can more accurately assess future risk.
Toward that end, she believes a focus that includes ESG will help drive alpha. “In fundamental strategies, ESG is at the core of effective risk management,” says Ms. Riutta-Nykvist, “and this is especially true during the time of Covid-19. ESG doesn’t impede profitable investing; it’s one of the keys to it.”
Seeing regional and global recession, she’s looking to direct new allocation into discretionary macro and systematic CTA managers who should be able to profit.
Aberdeen Standard’s Mr. Barlow agrees. Both strategies have so far contained the fallout through the first quarter of the year. As long as the broad markets in which they invest don’t trend sideways, he expects they should also be able to excel.
Prime Capital’s Mr. Wendorff is sustaining his 15% exposure to Global Macro and CTAs, and has slightly lowered his exposure to Distressed Securities to 25%.
“I personally don’t expect a full V-shaped recovery,” posits Mr. Wendorff, “but there’s really no way of knowing what to expect from markets, especially after having rallied so aggressively off their March lows.” This is why he’s remaining defensive with a core focus in Market Neutral and Relative Value funds.
He worries about the disconnect between climbing equities and likely serious reduction in demand after economies reopen. Echoing the sentiment of Dr. Kaufman, Mr. Wendorff says, “there will most likely be material destruction of capital and reduction in the level of risk taking by consumers and manufactures, which doesn’t seem to be figured into current market valuations and PEs that are returning to their pre-Covid-19 levels.”
He speculates retail investors, who fear missing out on the party, are fueling the current stock rally. “It feels more like a Bear Market rally, than a substantive recovery,” says Mr. Wendorff, suggesting more pain is likely to come.
“Covid-19 testing and lots of it,” he says, “is key to assess risk and opportunities. It’s no different than an analyst requesting financial data to help make a buy or sell recommendation. Currently, there are just too many unknowns out there.”
ERS Texas’ Mr. Lambropoulos agrees, saying it’s too difficult to determine fair valuations of most firms. As an allocator, he sees merit in raising cash, expecting markets to retest their March lows.
Looking out 6 to 9 months, Mr. Lambropoulos will be concentrating on the longer-term distressed cycle that government intervention will not be able to rectify. He anticipates “fundamental changes to operations in a weaker macro environment will lead to credit downgrades and a material increase in bankruptcies and takeovers.” This is where Mr. Lambropoulos expects to see compelling investment opportunities.
Ms. Riutta-Nykvist sees the same opportunities when the fog of Covid-19 begins to lift over the next year or two. She also will be tracking the prospects of emerging markets as economic conditions stabilize.
If there has been a glimmer of hope that the economy is beginning to dig itself out of this deep hole, or has at least stabilized, it’s been Big Tech, which has shown an ability to respond quickly to the crisis. CNBC reported in May that bell-weathers like Facebook, Apple, Amazon, Netflix, Google/Alphabet (and Microsoft) “have proven to be far stronger than other industries ravaged by the pandemic. The stay-at-home orders across the world have people using technology to work remotely more than ever, providing a big boost and more optimism around technology.”
Their services, software, and hardware are enabling a host of traditional businesses to function better and to permanently improve operational efficiency. This may suggest light at the end of this dismal tunnel.
Yet, there’s no way to be certain about the likelihood or severity of additional waves of Covid-19 cases or increased market uncertainty.
Economic historian Niall Ferguson fears governments are too focused on flattening just the current curve of cases. “There will be other curves,” says Mr. Ferguson, “unless this pandemic is completely unique in history. Fiscal and monetary measures only bought us a small amount of time. But my sense is that equities haven’t yet bottomed, and the rally that started in March in response to government intervention will likely fade.”
Nationwide demonstrations that broke out in response the police killing of George Floyd in Minneapolis in late May just as the country was beginning to open up is making restarting local economies harder and risking the flare up of Covid-19 hotspots across the country. This could potentially undo much of the progress made against the pandemic after several months of lockdown. If dense protests don’t accelerate the spread of the virus, then it may enhance the near-term outlook for the economy. Photo Credit: AP Photo/Seth Wenig
Volatility Trading: Global Sigma AGSF
Global Sigma AGSF’s consistent returns of more than 13% annually since it was launched in spring of 2013 has continued through the first quarter of 2020, with the fund up 2.5%.
The 2020 performance of the 20th-ranked fund was trailing the average Volatility fund, which was up nearly 8% through March. But in contrast with AGSF’s compelling long-term performance, this strategy as a whole has lost money over the last 5 years through 2019.
AGSF focuses on US equities, strictly investing in short-dated options on S&P 500 futures contracts, which typically expire within one week. He also invests in VIX futures contracts to help smooth volatility.
Manager Dr. Hanming Rao’s limited duration approach to generating absolute returns has enabled him to frequently identify options that are mispriced in comparison to expected near-term volatility.
In January, he saw options underpriced, suggesting lower volatility and risk than what the manager thought was reasonable. So he bought long options.
Then, reflecting the fund’s ability to respond rapidly to changing market conditions, it reduced exposure as volatility shot up in March by reducing leverage, executing fewer and more selective trades in response to changing market sentiment. Through May, the fund was now up 4.53%.
Opportunistic Distressed/Equity Investing: Mak One Capital
"We have entered a new period of enhanced volatility that may be with us for many years," says Michael Kaufman, head of New York-based opportunistic and distressed equity fund MAK Capital One (No. 4)—which generated net returns of close to 15% annually since its launch almost 18 years ago through the end of 2019.
The market panic, which disproportionally hurt some of Mr. Kaufman’s smaller cap holdings in hospitality technology and manufactured home building, has been the main driver of the fund’s -9.4% first quarter decline--in line with the hedge fund industry’s returns. By the end of May, Mr. Kaufman had reduced fund losses to
He’s assessing existing and future investments based on soaring public debt, which he thinks will act like an accelerant to future volatility, intensifying both the frequency and severity of future economic crises as governments struggle between solvency and constituent demands.
He will also closely monitor the impact major changes in business operations will have on valuations. Increasing "work from home" and Internet purchasing trends together could reduce the value of retail and central business district office property around the world along with all businesses that rely on that work traffic.
Kaufman is sticking with most of his companies, doubling down on some, while limiting net exposure to offset market volatility. And he’s looking to short companies he thinks will have serious problems responding to the new macro realities.
Niall Ferguson: An Economic Historian’s View
EU: How do you think the economy will fare in 2020?
NF: The IMF projected the US economy would contract by -5.9% in 2020. That’s assuming lockdowns are over in the 2nd quarter and a recovery in the second half. My expectation is not for a sustained V-shaped recovery. I anticipate the US will be hit by a second wave of COVID-19, which will inhibit recovery.
EU: What are financial markets telling you?
NF: Financial markets are sending false signals about the likely trajectory of the real economy and that’s because they are still responding to massive government relief programs, which for the time being, have prevented financial assets from cratering the way they did in 2008. The real economy has been hit far harder by Covid-19 than by the financial crisis of 2008-9. The Fed and the Treasury have built floors not just under equity prices, but beneath other asset classes, including non-investment-rated bonds. But this is an unsustainable state of affairs.
EU: Are we responding to the current crisis like we did 2008 or are we making necessary adjustments?
NF: We’re seeing a similar response that was made in 2008, but on steroids. We won’t be able to bring the economy back until we get a handle on the public health crisis. And the Trump Administration is not making it clear that’s it’s not just one curve we have to bend. There will be other curves, unless this pandemic is completely unique in history. Fiscal and monetary measures only bought us a small amount of time. Soon businesses will begin to die if there isn’t a return to work in the next few weeks.
EU: What does all this mean for markets and investing?
NF: Oil markets are showing there has been massive economic contraction the world over. My sense is that equities haven’t yet bottomed, and the rally that started in March in response to government intervention will likely fade.
Why Good Funds Didn’t Make the List
While a main reason most funds that didn’t qualify for inclusion in this list was due to inconsistent or lackluster performance, survey parameters excluded some very good managers. Examples include the concentrated Long Equity fund TCI (formerly The Children’s Investment Fund). Chris Hohn’s fund didn’t make the cut because his 2018 performance was 1%. This was well above the average hedge fund return for that year. But it was below the survey’s 5% hurdle. Mr. Hohn is a venerable fund manager, having generated more than 18% a year since TCI was launched in 2004.
Nigol Koulajian’s Alpha Quest Original fund has more than doubled the S&P 500 since it start in 1999, averaging annualized returns of 10%. During the first quarter of 2020, the Global Macro fund was up nearly 20%. Its systematic strategy, which targets sharp market moves, is designed to excel during major market downturns. But over the trailing five years through 2019, when volatility was extremely low, it generated returns of 2.4% a year.
Discus Composite, a Managed Futures program, has been returning 9.6% a year since it launched nearly 30 years ago. Part of the global asset manager Capital Fund Management’s portfolio of funds, Discus’ assets at the end of 2019 was less than $250 million, below the $300 minimum threshold for inclusion in this survey.
This independent study was commissioned for the 2020 SALT conference catalogue. The survey is not a recommendation to invest in any of the funds cited, an action that requires extensive due diligence before any allocation is made. All data comes from databases and proprietary sources that receive performance numbers directly from each hedge fund. Additional time was spent contacting each fund to confirm data. Nearly 3/4s of the funds confirmed data either through conversation or provision of performance documents. The author is not responsible for any data inaccuracies, especially those manifested unintentionally or intentionally through the data reporting process to third parties or to himself. All potential and existing investors must confirm all data before deciding to allocate or redeem.
Special thanks to Marina D’Angiolillo, research and professional services manager at Backstop BarclayHedge, for her extraordinary help for initially screening through thousands of funds in the firm’s database and performing specific fund analysis. Additional thanks are extended to William Clarke, manager of Preqin’s communication team, who also screened through thousands of funds for this survey.
All rights of this survey belong to Eric Uhlfelder and a licensing agreement must be secured with Mr. Uhlfelder for any commercial use of this document.
To access the final survey, which includes the 20 data points collected on each of the 50 funds that qualified for this survey--ranging from asset size and strategy, various performance and risk metrics, to correlation to the S&P 500--please contact the author at [email protected]
About the Author: Eric Uhlfelder has prepared 17 annual hedge fund surveys for Barron’s, The Financial Times, and most recently The Wall Street Journal. He covers global capital markets from New York over the past 25 years for various major financial publications. He wrote the first book on the advent of the euro post currency unification, “Investing in The New Europe,” for Bloomberg Press. And he has earned a National Press Club Award. His website is www.globalinvestmentreport.net
This report is in memory of David Schutt who first taught me the art of surveying hedge funds at Barron’s.
1 Eric Uhlfelder’s previous 16 annual reviews of the global hedge fund industry were commissioned by The Financial Times, Barron’s, and The Wall Street Journal.
2 Uhlfelder, Eric. "As Hedge Funds Struggle, These Are Standing Out," The Wall Street Journal, 6 May 2019. This survey of 60 funds was based on the same methodology as the current survey.
3 While these funds rode the back of last year’s strong rally, turning in the highest strategy returns of 15.28% in 2019, it makes their trailing 5-year annualized returns of the 464 funds of 4.5% surprisingly low—especially given the bullish sentiment that has prevailed during most of this period. Their first quarter 2020 performance was among the worse of all strategies, down 16.63%.