With Long/Short Investing Dead, The Days Of LTCM Strategies Are Back As Market Plants Seeds Of Own Destruction
We have long observed the decline and eventual death of fundamental analysis, courtesy of i) the Fed's dominance of capital markets, ii) the emergence of HFTs and technicals as key driving forces behind the stock market, and iii) the record implied correlation between all stock asset classes, meaning everything trades as one. Ironically, the result is that reasonable, long/short investment strategies no longer generate a return (alpha or whatever one calls this relic of efficient markets), and instead we are back to the good old "pennies in front of a steamroller" strategy that was so "successful" and made so popular by such spectacular implosions as LTCM. Don't take our word for it - the FT reports: "The hedge fund strategy pioneered – and made notorious – by Long Term Capital Management is returning to prominence amid one of its most successful years yet, aided in large part by the massive issuance of bonds by the UK government and other sovereigns." In other words, the market is now stuck in a mode (courtesy of central planning) which guarantees that the only way to make money, sets the seeds of the markets' own destruction. It is only a matter of time before every investment strategy follows in the flawed footsteps of John Meriwether (who unfortunately can't participate in today's market due to three prior collapses, or else he would be making mint) and soon every single asset manager (not due to their own mistakes, but basically as a function of what the market rewards now) will follow a fate which will appear like an LTCM-like supernova in which every spread convergence trade explodes to historic divergence in a span of seconds.
Fixed-income relative value trading – shunned by investors after the collapse of LTCM in 1998 – has been one of the industry’s few outperformers this year, thanks to massive pricing anomalies caused by fiscal stimulus packages and unconventional central bank monetary policies around the world.
According to Hedge Fund Research, the average relative value fund has returned 5.33 per cent so far this year, compared with just 1.52 per cent from the average hedge fund. Relative value trading involves identifying “inefficient” prices in bonds – typically government bonds – and wagering that the prices will correct over time.
With mainstream hedge fund strategies such as equity long/short and global macro floundering amid volatile markets, relative value funds have seen their inflows increase. The strategy has taken in $10bn (€7.8bn) from investors this year – accounting for close to half of the entire industry’s inflows.
Among the strongest performers so far has been the $550m Barnegat fund, based in New Jersey. The fund, which was set up after the collapse of LTCM and has recently opened to outside investors, returned 6.5 per cent in July and is up 16 per cent so far this year. The $4.5bn London-based Capula, the world’s largest relative value fund, was meanwhile up 6.78 per cent for the year as of the end of July, according to an investor.
And the irony of confirmational bias:
Relative value funds have also benefited from a thinning of competition. Prominent relative value hedge funds, such as Platinum Grove and JWM Partners, have shut down, while banks – once big-time players of relative value trades thanks to their deep pockets and ready access to cheap finance – have exited the market en masse.
Or, perhaps we, and every other realist is wrong, and the Fed is truly smart enough to be able to run centralized planning effectively for the largest economy and most complex economy in the world...