2018 Hedge Fund Performance and How a rising Estonian Fund beat the world’s largest Hedge Funds.
“There is blood in the streets” as Baron Rothschild would almost certainly say about the fourth quarter of 2018. 10 years after a grim 2008, hedge fund managers are once again left scratching their foreheads after one of the worst years for hedge funds since the financial crisis. As nearly all asset classes finished in negative territory, the average hedge fund posted a loss of 6.7% for the year, according to the HFRX Global Hedge Fund Index.
In fact, utilities and health care were the only two sectors in positive territory towards the end of 2018, making it an extremely challenging year for stock investors.
In the last decade, stocks have been a major beneficiary of the loose monetary policy engineered by most central banks in the past decade. In this environment, companies have been able to borrow money cheaply which allowed them to aggressively expand their balance sheets and boost earnings as the economy slowly staged a recovery.
Large returns in stocks over the past 10 years, unfortunately, were not reflected in the performance of the average hedge fund, which consistently underperformed the major indices. At a glance, this doesn’t look good for the hedge fund industry. However, only looking at the dry powder omits a very important detail which explains the hedge fund industry’s underperformance. That is, to achieve the absolute return hedge funds are aiming for, they needed to constantly be, well…hedged. Of course, looking back with a high dose of hindsight, they didn’t have to be.
But the tide has turned. Now that interest rates have started to rise and monetary policy is beginning to tighten, investors have begun speculating on how these high-levels of corporate debt will affect the companies’ balance sheets. The result? Cliff-like charts, roller coaster intra-day moves and major spikes in volatility.
In December of 2018, The CBOE Volatility Index (VIX), often known as the “fear gauge”, hit its highest level (36%) since February 2018, when concerns over economic growth in China caused stock markets to retreat. Typically, this is positive for hedge funds as it lets their hedges kick in and their fund managers earn their stripes, as they tend to significantly outperform the indices. However, it seems most of them were not ready for the level of volatility December brought. Maybe it’s true what they say about good times creating weak men…or maybe it’s just the fact that December 2018 was the worst December for stock since the Great Depression.
So who disappointed?
The Global Picture
David Einhorn’s Greenlight Capital had their worst year ever dropping 9% in December alone and ending the year with a massive 34% loss. Greenlight’s largest holdings include General Motors, insurer Brighthouse Financial and homebuilder Green Brick Partners, which all struggled in 2018, bleeding as much as 47%. With the fund’s massive underperformance compared to the S&P 500 (which ended 2018 down just 7%), it can be looked at as an odd year for Einhorn, who in his early years, scored some of Wall Street’s best returns including 24% in 2006 and 32% in 2009 as he called the collapse of Lehman Brothers. Recently Einhorn compared Lehman Brothers to Tesla, which he recently started actively shorting.
Then there is the all-star activist investor Dan Loeb’s who’s Third Point fell 11 % thanks to positions in industrial names like United Technologies and DowDuPont. Loeb’s firm lost about 6% in December alone. Prior to 2018, Loeb had nearly doubled the S&P 500’s return for more than two decades, returning as much as 18.1% in 2017, while many of his peers significantly underperformed the market.
Bill Ackman’s Pershing Square Holding performed significantly better but still ended the year down 0.7%. His earnings were boosted by long bets on ADP and Chipotle.
Despite the chaos, there were a few bright stars who managed to leave everyone in the dust.
In part due to his famous Principles, Ray Dalio’s Bridgewater Associates’ flagship fund Pure Alpha Strategy, rose an impressive 14.6%. As one article put it, “Radical Transparency compels Ray Dalio to tell you he f***ing killed it last year.” Dalio was heavily criticized in early 2018 when he said that investors would feel “pretty stupid” for holding cash, which until the end of the year seemed to be the only asset class with any positive returns. Dalio didn’t seem destined for such an incredible performance as while stocks did take-off for a stretch following his call to put cash in the market, it didn’t take long for things to turn ugly and for the mainstream media to turn on Dalio.
But laughs he who laughs last and Bridgwater, which with $160 Billion in AUM is the world’s largest hedge fund, has definitely delivered for its investors.
Another bright star is the leading quant firm Renaissance Technologies originally founded by Jim Simons. The Renaissance Institutional Equities fund gained 8.5% last year, the Renaissance Institutional Diversified Alpha fund returned 3.23% and the Renaissance Institutional Diversified Global Equity fund made an impressive 10.3% return. Of course, investors would love to know the performance of the firm’s oldest fund, Medallion, but as it’s open only to the company’s employees, it’s performance is not publically known.
According to John McCormick, chief executive of Blackstone Alternative Asset Management, “Quantitative firms that have made very significant investments in infrastructure, technology, data sets and human capital have an ongoing competitive advantage.” It is those firms that have been able to put up a solid performance for 2018.
Other global funds worth mentioning are DE Shaw’s $14bn Composite fund which gained 11.2%, Two Sigma’s Absolute Return fund that made 11% and it’s “global macro” Compass fund that was up 14% for 2018.
An Estonian Fund — A Rising Star from an unexpected place
The outlook on the Estonian fund market is quite similar to the global outlook with most funds, underperforming the major indices and suffering loses for the year. Within this group, however, one rising fund managed not only to outperform the rest but to match the spectacular performance of Ray Dalio’s Bridgewater fund.
The FB Opportunity Fund, an Estonian fund managed by FB Asset Management, has earned 14.5% for 2018 using hedge fund strategies. This performance is remarkable not only compared to their peers in Estonia, but the fund managed to outperform almost every single one of the largest funds in the world coming in with just 0.1% under Dalio’s Pure Alpha Fund.
The fund had a phenomenal year with Q4 as it’s best quarter. It earned 2.09% in December alone, a month which was absolutely deadly for most hedge funds in the world.
How did they do it?
The fund doesn’t follow a classic a long/short fund strategy which saved it from bleeding at a time stocks were hammered down. The fund trades weekly option spreads on the S&P 500 and uses its proprietary models and standard deviation theory to calculate the probability of reaching each strike price within a week. The idea isn’t to find where the index will be, but rather where it will not be a week from today. Trading such index spreads consistently allowed the fund to avoid long exposure to any individual stock and have a positive return in 11 out of 12 months of 2018. The fund is currently up 47% since inception and has a double-digit return for three years in a row.
As for the rest of the Estonian fund industry, here are some of the returns of funds which made their 2018 numbers public:
The performance of Pension Funds in Estonia for 2018 was also underwhelming. While 4 of LHV’s funds managed to be profitable for the year, all pension funds without exception had a negative real return if factoring inflation.
To summarize, 2018 was a tough year for most money managers. It is in such years that new stars are born and seasoned professionals get to solidify their positions at the top. As they say, pressure makes diamonds.
Last year’s clear winners are Ray Dalio’s Bridgewater, Renaissance Technologies and FB Asset Management’s FB Opportunity Fund. Unfortunately the list of funds that lost money in 2018 is significantly larger and more diverse.
While the reputation of hedge funds may have been questionable over the past decade, in times like these, it’s the quant companies who have some sort of an “edge” be it in technology, algos, human capital or a different “idea” that are able to safely manoeuvre the volatility on the markets. Furthermore, one must not forget that if we “zoom out” and look at the bigger picture, hedge funds have historically beaten the markets by a good margin.
Successful investing.
Mihail Burõhh
