Martin McCubbin, a senior research analyst at Fidante, looks at the hedge fund performance numbers for 2018 in a new paper, which shows it was a difficult year. Early going in 2019 has been somewhat better, but that the “better” cannot be relied upon. The rest of this year could be as rocky as was the last—or worse.
The bottom line for 2018 was: the HFRI Fund-Weighted Composite Index was down 4.7%. This was the worst annual return since 2011. At the end of the year, the trailing 12-month return reached its lowest point since early 2016.
In January 2018, performance was positive. But by February inflation worries took over, creating a considerable sell-off in equity markets that hurt many hedge fund managers with a “generally positive beta” on equity markets. And the end of the year was especially brutal, “including concerns over rising rates in the US and the ongoing US/China trade war.”
Among the casualties, the macro funds were hurt by sudden reversals in their markets. They were down 4% for the year.
There were lots of mergers in 2018, and the merger arbitrage index shows that hedge funds that focus on reaping the benefits of such events did a lot better than those with other strategic mandates (up 3.3%). But the broader event-driven index was down 2.2%.
On the other hand, as noted above, the first two months of 2019 were brighter. McCubbin attributes this to “the re-establishment of the risk-on market environment,” and to the fact that there was so much selling in December that many assets can reasonably be thought underpriced, given their fundamentals. Hedge funds have been able to shop in the bargain basement.
An Empty Bargain Basement
But McCubbin also believes that the bargain basement has been emptying out. The gains that could be realized on the basis of “buy when others are fearful” have already been realized, and the rest of 2019 may again be difficult. He says that if a favorable Brexit outcome can yet be achieved, “there could be strong gains across risky assets for the UK, which could contribute positively to hedge fund returns.” But he also says that prospect is unlikely.
Further, the signs of continued economic results are wavering. We are experiencing the “latter stages of an economic cycle,” and there is historical data about which hedge fund strategies perform best in these stages. As McCubbin, and Fidante, see it, short-biased equity funds are promising, hedge equity and event driven funds are not. Statistical arbitrage and equity market neutral funds are on a middle stool.
“[Given] the uncertain backdrop,” the paper says, “multi-strategy funds may be best placed to deliver relatively attractive risk-adjusted returns over the next year or two."
Listed Hedge Funds
McCubbin/Fidante also looks in some detail at listed hedge funds as a distinctive sector. At least one listed fund with a diversified strategy stands out as having bucked the negative trends of 2018 adeptly. BH Macro was up 12%. That is coming off a losing year in 2017 (-4.4%).
The majority of funds in the listed sector have positive numbers in 2019 YTD. Pershing Square Holdings has the best number there, up nearly 30%. But the comments made in other sections of the report concerning the likely course of events for hedge funds in the rest of this year also apply, this paper suggests, to those in the listed sector.
The Preqin Survey
McCubbin also reviews a Preqin survey about hedge fund investors, their attitudes, their plans. Preqin says that 55% of investors say that investors have fallen short in the last year. Still, most investors say they will either maintain or increase their investment in this asset class through 2019. Specifically: 53% plan to maintain and another 26% to increase. A positive attitude, so understood, is at its highest level by Preqin’s counting since late 2014.
Why such a positive take after such a bad year? Because “hedge funds are seen as a necessary portfolio diversifier and a risk reducer in volatile markets,” and increased volatility is expected. A sizeable majority (59%) of Preqin’s respondents say that we are at or close to the peak of this equity market cycle.