Note: This article is courtesy of Iris.xyz
By Don Steinbrugge
The following comments are excerpted from Agecroft Partners’ Don Steinbrugge’s presentation delivered at the 69th CFA Institute Annual Conference held on May 9th, 2016 in Montreal. In Mr. Steinbrugge’s session titled “What Current Trends Tell Us about the Future of the Hedge Fund Industry” he discussed a number of the recent quotes and articles directed to the hedge fund industry that were covered broadly by the media.
Third Point Capital CEO Dan Loeb thinks hedge funds are in the first stage of a “washout” after “catastrophic” performance this year.
The HFRI Fund Weighted Composite Index posted a decline of -0.67 % in Q1 of this year, which on the surface isn’t that bad. Upon closer examination, this moderate decline is hiding the vastly different paths various managers and strategies traveled during the quarter.
In January and February, strategies with a lot of beta, exposure to the equity and fixed income markets, such as activists, long/short equity, and distressed debt, generated very poor performance, which was significantly worse than most investors’ expectations. Investors do not mind if these strategies underperform during a bull market, but they are expected to reduce downside volatility during periods when the market sells off. Fortunately, these strategies rebounded significantly during the month of March and only finished the quarter slightly down. Nonetheless, investors remain disappointed that these strategies did not provide the downside protection they expected.
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Strategies that are uncorrelated to the capital markets performed very differently. For example many direct lending and reinsurance managers posted positive returns in each of the first three months. Market neutral and relative value fixed income managers generally exhibited significantly less volatility than high beta oriented strategies. CTAs, although volatile, enhanced a diversified portfolio’s Sharpe Ratio by being negatively correlated during the quarter; they were up in January and February and then gave back some of the gains in March when other strategies rallied.
What is also not apparent when looking at the quarter’s performance is the huge dispersion of returns exhibited by managers within each strategy. In many cases there was over a 20% differential in returns between the best and worst performers within a single strategy. When strategies underperform investors’ expectations and when dispersion of returns between managers increases significantly, it results in a significant increase in fund redemptions, especially for those managers that underperformed.
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