After suffering a historic beatdown in 2018, when they generated the worst absolute return (or rather loss) since the financial crisis, 2019 is proving to be just as painful for the hedge fund crowd.
First, the good news: according to Hedge Fund Research, funds have climbed 4.9% in 2019 according to the Bloomberg Hedge Fund Database, rebounding sharply from the previous three months, largely thanks to beta chasing buoyant equity markets equity markets rewarded managers. All seven strategies advanced from January through March, with equity hedge and event-driven funds leading gains.
Now the bad news: the industry's return is paltry compared with the 13% gain in the S&P 500; this underperformance means the hedge fund industry is headed for its worst relative start of a year since 2012.
And so stuck in limbo where hedge funds face a choice of either doubling down to catch up to the market, or waiting on the sidelines for the next correction/crash, the best paid financial professionals are picking the latter.
As we have been reporting week after week, showing that investors continue to pull funds from equity funds, Bloomberg today also notes that hedge funds have "stubbornly refused to embrace stocks even as global equities added $10 trillion in value over the last three months." Citing data from JPM's prime brokerage group, at the end of March, hedge fund net exposure as measured by the ratio of bullish bets to bearish ones stood near the lowest level in more than a year.
To be sure, the lack of bullishness among the smart money has been cited by a chorus of bullish strategists, most notably JPMorgan's Marko Kolanovic, as evidence stocks will rise further as they are forced to throw in the bearish towel and chase beta (if not alpha) by levering up and buying stocks. In fact to the bulls, it is this moment of capitulation when Fed dovishness eventually forces everyone back into equities, that defines many a bull case.
And yet the jury is still out on whether the market is wrong, or hedge funds: as Bloomberg adds, it is of course possible that "hedge funds will stick to their guns and resist jumping in." This would be a mirror image of what happened in the second half of last year, and paid off when the S&P 500 plunged to the brink of a bear market (and while most hedge funds did not escape unscathed, their losses were less than the broader market).
The buying boycott by hedge funds has also prompted many to ask who is buying, to which BofA earlier today presented the following answer:
- corporates, also known as "buybacks", which have purchased a record $270BN YTD as of end-March, and
- investors via derivatives (US index delta-adjusted open interest now $446bn vs -$1.2tn at Dec'18 lows, and $916bn at Jan'18 highs). This is the infamous gamma imbalance, where the higher the market rises, the more dealers are forced to buy.
That said, their skepticism has not (yet) denting demand for hedge fund services, and as Bloomberg reminds us, "about a third of respondents in a separate JPMorgan survey said plan to boost allocations, up from 15 percent in 2018." Which would, at least superficially, suggest that more and more investors are convinced that the market is wrong and skeptics are correct.
"It’s for differentiated exposure but also some positive returns when the market turns south," said Crit Thomas, global market strategist at Touchstone Advisors in Cincinnati. "I’m not sure the pressure really necessarily is there or not."
Well, it is, only it is still early on in the year, and for now hedge funds have the luxury of waiting; however in a year which as BofA earlier today said is shaping up as the best year for stocks in terms of annualized performance in history, with every passing week, more and more hedge funds will reach the point of panic and fear they will be bombarded with redemption requests as we approach the end of the quarter and certainly, 2019, in a replay of what happened last year.
Meanwhile, hedge funds are doubling down on bearish: according to Goldman, in the final week of March, "hedge funds sold stocks and raised their bearish bets, particularly in financial and industrial shares." Confirming the lack of animal spirits, hedge fund net leverage slipped by another 2.2% points to 61.7 percent. That would be a 4th percentile of a one-year range.
Finally, as Bloomberg notes, any number of concern could be keeping hedge funds on the fence. The easiest to explain is the state of the economy and corporate earnings, both of which are forecast to see slowing growth in 2019.
"They’re not participating because they see this rally as more driven by sentiment as opposed to underlying fundamentals," Touchstone’s Thomas said. "It’d be better visibility of a true turn in fundamentals that would bring them back in."
And just to make their lives even more difficult, earlier today president Trump made his first open appeal to the Fed to launch QE4, which ironically did not help push stocks much higher, for one reason: the thinking goes that if with 3.8% unemployment, rising wage growth, a resilient labor market, rebounding manufacturing surveys, a suddenly resurgent Chinese economy, a slowdown in the recent housing market slide, and last but not least, stocks less than 2% from all time highs, the president is willing to push the Fed to enact such emergency measures as more quantitative easing, then nobody has any idea what is really going on with the US economy, and expect the investor paralysis to continue indefinitely...