Observation of
quantitative metrics and the qualitative conclusions we draw from them is the
cornerstone of any good analysis, in whichever field of application. Equally ass
important is the window of analysis, i.e. the period/s observed. FPM considers
the 5 and 3 years performance period of hedge fund strategies as averaged by
HFRI, an index provider benchmarking hedge fund performance. We extended these choice
periods to include trailing performance data for the last 3 months of the starting
year. In actuality we do not use the clean January to December as an annual period.
In this extended window started from Oct 2008 and October 2010, for 5 years and
3 years windows respectively, we believe we incorporate both year-end ‘window
dressing’ performance boost and early yearend profit-taking and consolidation
in weak capital market years.
Our performance
snapshots of 3-periods as above, of HFRI Hedge Fund Weighted Composite Index
and market proxy S+P 500, shows equity markets reflecting economic recovery
in recent years, “The Good Times”. First table is a painful reminder of The Bad Times from Lehman and March 2009 lows - less said the better! he second table above reflecting ‘5.25’
years of performance negatively includes the last major market low of March
2009, “The Good and Bad Times”.
Stark Point: The relative
indifferent performance of hedge funds over the Good Times is an observation
for elaboration. The hedge fund allocation proposition over weak and declining
markets seemed justifiable after compounding 32.3% over The Good and Bad Times.
Yet in steadily recovering equity markets with low volatility since 4Q11, the
hedge fund proposition seems to be blowing ‘hot air’ i.e. no absolute substance;
compounding at a mere 16.1% (annualised at 4.7%) over the three and quarter
years to end-December 2013!
Therefore,
should hedge fund allocators be switching to lower fees long-only funds in this
benign economic recovery era and capture full upside gains, or should we stick
with higher fees hedged investments expecting market turbulence?
FPM portfolio
strategy has always been to suggest balanced portfolio. The extent of being
“balanced” is at the financial savvy of the experienced portfolio overseers. We
have indeed been advocating “Core-Satellite” approach as our veritable
performance kicker strategy on the premise of a 10-year realistic recovery
cycle since the “Great Recession”. We have expounded this top-down portfolio
composition strategies to our Middle Eastern allocators including SAMBA Financial Group. Who consider it too intensive to bother about as SME hedge funds to park a minimum US$ 7 mn proprietary money. Talk about job creation in financial services!
Our pictorial
depiction above, shows how FPM would have increased weighting to equity and
other long-only mutual funds, exchange traded funds, closed-end funds etc -
other things being equal. The catch-all caveat would be based on our economic
and market outlook. In the nature of hindsight we can obviously see this
“switch weighting”. In the same way we are looking forward for signals as
foresight. FPM believes the last 2-3 years of benign markets scarred with the
odd flash crash augurs a meaningful correction this year and into 1Q15,
cyclically predicted.
Despite the
market propping, artificial stimulus and a good dose of “confidence boosting”
media, FPM does not evidence a 'wipe-the-slate-clean' meaningful recovery. A stop-start characterised capital markets reflecting slow / stagnated economic fundamentals amid geopolitical tension is our global medium term outlook.
Macro and Markets – An Outlook
Along with the
Federal Reserve we cite unemployment as a major drag, even though confidence
boosting numbers shows an improving circumstances, but the reality is the old
trick of statistics being used for untruths. Just witness any critical blog on
the Federal jobs numbers to see the extent of confidence boosting manipulation
of the data.
Less of a drag
factor on the economy for the countries with their own prominent currencies,
like the US, UK and Japan, Switzerland etc, is the eventual
onset of inflation tendencies. While inflation is already a concern for
emerging markets or developing countries with stronger growth potential and
more fundamental monetarism linked to exchange rate and interest rate tweaking
policies.
Economic
fundamentals such as jobs and deflation continues to dampen growth prospects,
which are also structural in nature in developed nations, FPM anticipates cataclysmic event/s bring about a meaningful capital
markets correction. News of toxic subprime had less impact as a catalyst
for the Great Recession than did Lehman Bank’s demise in late 2008. To herald
such turbulent outcomes we quote a timely Gordon Gekko below (as The Wolf of
Wall Street is on general release in cinemas):
“We
make the rules, pal. The news, war, peace, famine, upheaval, the price per
paperclip. We pick that rabbit out of the hat while everybody sits out there
wondering how the hell we did it.” Gordon Gekko, “Wall Street”, 1987
With that in mind, to imaginatively pick a cataclysmic
economic and market shock event we see debt default by a leading developed country
or countries. Our disaster scenario does not
preclude large corporations, like the US’s largest borrower General
Electric Co. (GE) going belly-up. The lending division GE Capital had about US$
229 bn of debt, greater than 20x the liability at the consolidated group level.
We are already seeing “begging- bowl” borrowing to keep afloat in some of the
fringe companies / countries, e.g. in the European Union. Thus far, either
news-managed as insignificant without market shock and / or b) orderly and
timely solutions have been set-out by authorities. Viz, US shutdown in October
last year for 16 days and at the same time Reuters reported: “The government also came close to breaching
its borrowing limit, which compounded the crisis and could have pushed the
country closer to a historic debt default.”
Under FPM’s
macro economic outlook and expectations for a meaningful correction we still
believe many hedge funds exhibit hedged bets and absolute performance
regardless of market conditions. Therefore, FPM recommends core holdings still in
hedge fund strategies rather than ETFs; or other relative return products and
re-weighting satellite allocation to liquid blue-chip and large cap equity
funds.
In our February
2013 preview of macro and market fortunes in Investment
Sector Outlook for 2013: “Credit is a Lover on the Re-bound?” FPM’s opening
gambit was “FPM considers the macro
speculation that policy makers’ credit cycle stimulus is in musical terms at a
moderata end in 2013…”. The euphemistic “tapering” jargon has taken grip to
symbolize that which FPM predicted. FPM is in-the-money for sure!
Hedge Fund Strategies – An Allocation Policy
Strategically
and selectively FPM are swerving away from large institutional hedge funds,
they are not only a misnomer as core of their portfolio can resemble any other
long-only Vanguard-like fund, but ultimately producing strategy average returns
or in some cases underperforming beta returns. Too illustrate this, compare top 10 holdings of hedge
funds via SEC 13F filings and a mutual fund constituents. SNAP! The household
names stocks are too similar in the large hedge fund portfolios to represent actively
managed absolute alpha generation. The audacious cheek of those hedge fund fees
when hedge funds become large asset gatherers!
Aside of the
principle that small is beautiful in hedge funds, we still hark and marvel the
risk-return performance of the Relative
Value Fixed Income – Asset Backed Index, as extracted below. Annualising
12.3% return since beginning of October 2008. Remember that month alone the
S+P 500 plummeted 17% plus a further 7.5% the following month November.
Of the 32 HFRI
hedge fund indices and the S+P 500 which we compared this asset-backed
strategy has consistently outperformed. Apparently those hard-to-value
referenced debt pools are majority still performing-loans with the help of
Uncle Sam’s restructuring incentives and artificially-stalled interest rates
etcetera. We identified funds and
managers in this stellar segment of hedge funds in our September 2011 post “Credit
Markets @ Workout Inflexion Point”. Under our traffic light scoring system
this strategy gets “Green for Go” against 5 metrics, including best Sharpe Ratio! In film parlance as at this time of year, the strategy has gained the
equivalent of 5 Oscars Awards - the most among 32 hedge fund benchmarks!
Included among
these benchmarks is the Relative Value
(Total) Index, which itself annualised 7.5%. The “Total” index is composed
of sub-segments such as convertible arbitrage. As a an aside, this article
writer recommended convertible arbitrage to his then manager, when writer last
worked at an institutional hedge fund administrator.
Apart from the listed
relative value strategies other top compounding hedge fund sectors are presented
below as “The Next Top 5” from the past 5+ years investments.
Not surprisingly
and close behind was the US Dollar denominated hedge fund proxy “Fund Weighted Composite Index”
compounding 32.3%. Of these classic strategies, yet dubbed alternative, we
noticed the absence of Macro strategies. Clearly these guys were mostly
beguiled and flummoxed by the unprecedented flux in policy issuance from
co-ordinated global governments in the last 2 years. FPM have noted in its
5-years hedge fund performance review to end-March 2012, that Macro investing
was then the strongest performing strategy over the financial crisis. A more
critical assessment suggests not only were macro managers’ economic strategy
skewed but that their trading practices, stop-losses and technical
trend-following also got awry.
Mitigating macro
forecasters’ recent poor showing is the humongous and alarming extent to which transfer of
public wealth to private financial concerns resuscitated the
economy. The scale to which the Federal Reserve alone has increased its balance
sheet to approximately $4 trillion could not arguably have been conceived by
many policy watchers. Whether we can navigate through impending storms with
normalised policy response, i.e. without the crowding-out effect of government
purchasing its own Treasurys and mortgage-backed securities, is FPM evince our
debt default scenario.
