Over the past several years we have repeatedly stated that despite protests to the contrary, the single biggest factor explaining the underperformance of the active community in general, and hedge funds in particular, has been the ubiquitous influence of the Fed and other central banks over the capital markets, coupled with the prevasive presence of quantitative strategies, HFTs, algo trading and more recently, a surge in price-indescriminate purchases by passive, ETF managers.
Specifically, back in October 2015, we wrote that "as central planning has dominated every piece of fundamental news, and as capital flows trump actual underlying data (usually in an inverse way, with negative economic news leading to surging markets), the conventional asset management game has been turned on its head. We have said this every single year for the past 7, and we are confident that as long as the Fed and central banks double as Chief Risk Officers for the market, "hedge" funds will be on an accelerated path to extinction, quite simply because in a world where a central banker's money printer is the best and only "hedge" (for now), there is no reason to fear capital loss - after all the bigger the drop, the greater the expected central bank response according to classical Pavlovian conditioning."
Several years later, Goldman Sachs confirmed that we were correct. In a note released this April, Goldman's Robert Boroujerdi asked in a slide titled "Does Active Have A QE Hangover" and showed that the current run of active manager underperformance began shortly after the onset of QE.
The slide in full:
As we concluded at the time, and on numerous times previously, while hedge funds, especially established ones with significant AUM, find the current status quo relatively comfortable - after all they get to clip their management fees year after year (forget the "performance" upside), extrapolating current trends in central-bank dominated markets would eventually lead to "active" extinction, and the complete domination of ETF-based and other low-cost passive strategies. Furthermore, taken to its thought experiment extreme, a situation in which there is only passive management would guarantee that the next market crash would be truly unprecedented with few hedge funds there to hunt for bargains.
We added that in an ironic twist, the only event that could break this sequence of events would be a market crash, one which finally ends the current pernicious disequilibrium and resets the capital markets.
"For that to happen however, both the Yellen and now Trump put would have to be eliminated. And that, as the past 9 years have shown, is easier said than done. For the sake of hedge funds and their dwindling assets under management, however, they better fund a way and soon."
With the "resetting" market crash still elusive, where are we now?
As Bloomberg's Saijel Kishan writes, looking at the increasingly gloomy macro hedge fund landscape, "Financial markets no longer make sense to macro managers like Mark Spindel."
After spending three decades focusing on things like economic trends, currency moves, politics and policy, Spindel has been confounded by markets shaped by low volatility, algorithms and more. He finally gave up and closed his nine-year-old hedge fund.
Spindel's lament is familiar to anyone with no choice but to trade a market that, well, no longer make sense: “I felt the intensity of following markets at a time of increasing political and economic confusion very hard,” said Spindel, founder of Potomac River Capital in Washington. “My entire career had centered on an understanding of monetary politics and I had trouble getting my head around it all. It was exhausting.”
It's even more exhausting now when everything finance professionals have learned and practiced their entire careers has been turned upside down.
These are troubled -- and troubling -- times for macro managers, those figurative heirs of famed investor George Soros who were once dubbed the masters of the universe. They’ve barely made money this year and once again, their returns pale next to those of cheaper index funds. Many investors are looking elsewhere.
Andrew Law at Caxton Associates has posted record losses. Alan Howard had the worst first-half in his hedge fund’s history. Even the old hands in the business such as Louis Bacon haven’t been spared from losses. And Soros’s son, Robert, conceded last month that his family firm has made fewer macro bets amid “lackluster” opportunities.
Here Bloomberg asks, rhetorically, the same question we have been asking for years: "It’s enough to make a macro man wonder: in an age of untested central bank measures and algorithms, can this classic hedge fund style pay off like it used to?"
For many, the answer is increasingly no.
And it's not just central banks: in an age in which information travels at light speed by laser between Chicago, New Jersey and New York, what used to be an information advantage has been largely lost to most active investors, as "funds face an onslaught of technology that’s disseminating information more quickly and widely, while some algorithms are able to spot -- and capture -- price anomalies almost instantly. And computer models can more cheaply follow market trends."
The returns show it: according to Hedge Fund Research, Inc., macro managers on average returned less than 1 percent in the first half of 2017 and barely made money in the past five years. That compares with 2.6 percent this year by the broader hedge fund industry and 1.9 percent annually in the past five years.
This too is something we showed nearly a year ago, last August, when we demonstrated that the vast majority of hedge funds haven't generated Alpha since 2011.
The post-central banking world regime change was even more obvious in the next chart:
And it's not just Macro: it's everyone.
There was some hope in the wake of President Donald Trump’s election win, when the "macros" won a brief reprieve at the end of 2016, only to see their fortunes reverse in 2017 as the dollar and oil declined, stocks rallied and a political crisis erupted in Brazil. Volatility in equity and currency markets also fell to their lowest in years. In recent weeks, though, the dollar and Treasury yields have risen amid a hawkish tone from developed-nation central banks, which in turn has slammed risk-parity funds, who on several days in the past month have come dangerously close to sharp deleveraging levels.
Meanwhile, investors understandably have lost patience with the strategy. "They pulled about $3.8 billion from discretionary macro managers in the first quarter, the fifth straight quarterly outflow, while adding $4.9 billion into computer-driven macro funds, HFR data show."
After we warned for years about the pernicious impact of central banks on investing returns, slowly but surely that allegation became mantra among the active investing community:
For years, managers have blamed central bank policies for their failure to deliver stand-out profits. Low interest rates globally made it harder to make money from differences among nations, they say. And as computers probabilistically forecast economic and market data, some managers say it’s a challenge to compete with algorithms that can be a driver of short-term price action, and create shorter and sharper investment cycles.
As a result, many legendary names decided to leave the market altogether. Others looked inside for answers:
Spindel, a former investment chief at a World Bank unit, is searching for answers to why macro didn’t work for him. Things started going awry for the 51-year-old just after Greece skirted Grexit two years ago. Spindel was wrong footed by China’s currency devaluations and Brexit -- at times trading from his couch at home during the night to keep abreast of political developments overseas.
Over a salad lunch during a visit to New York last month, Spindel recounted times when he got his economic forecasts right but market predictions wrong. He referred to charts that show a declining relationship between economic-data surprises and bond yields, and discussed how he was perplexed by new central bank measures.
Spindel's lament is the ever greater tide of complacency that has swept across capital markets in recent years.
“The dispassion felt harder in the Grexit-Brexit window,” Spindel said, whose fund generated an annualized 11 percent return from 2007 to July 2015. “Markets had become increasingly disconnected with economics and politics.”
This, too, is something we first discussed last weekend when we showed that according to Deutsche Bank calculations, the market "snapped" in 2012, when the correlation between market volatility and policy uncertainty diverged terminally, and has yet to look back.
Deutsche bank dubbed this decoupling market "complacency", and was able to quantify it as such.
To be sure, the standard fall back laments would be present: "In addition, increased regulation and fee pressure made it more expensive to run his $760 million firm. After losing 12 percent through September last year, he returned money to clients."
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And while one can hunt for the excuses day and night, the unpleasant bottom line remained: it was cheaper and more liquid to simply invest money directly in the S&P 500 itself. After all, to borrow a phrase we have used countless times, "when central banks act as the market's Chief Risk Officers, who needs hedging?"
“The elephant in the room is that macro should have done well in the past seven or so years because of all the political and economic events,” said Adam Duncan, a managing director at Cambridge Associates, a Boston-based firm that advises clients on investing. “Yet no one has made any money. The idea that the opportunity set hasn’t been there is just not true. Markets have been moving all over the place.”
Indeed it has, only in largely unpredictable ways, usually in response to unexpected central bank intervention: "For example, in the past two years the pound touched its lowest against the dollar in more than three decades, the Canadian dollar fell to its lowest since 2003 and gold dropped to a five-year low. Managers need to increase risk and some should do more tactical trading, which is moving in and out of positions more frequently, Duncan said."
Which, for those managing billions, is far easier said than done. The revolution in the "market" prompted some founders to rethink their business models, "especially those who employ scores of managers that have been hamstrung by risk limits. They’ve cut their fees while some have stepped to the fore."
Among the most adversely impacted has been the formerly legendary macro HF, Brevan Howard.
Howard, whose clients are fleeing his Brevan Howard Asset Management, delegated management of his firm in September to deputies so he can focus on markets, according to people who know him. And earlier this year, the no-nonsense, straight-talking billionaire turned to coach and U.S. chess champion Josh Waitzkin to help hone his trading skills, the people said. Waitzkin, who was the subject of the 1993 film “Searching for Bobby Fisher,” runs programs that involve practicing mindfulness and journaling, according to his website. Brevan has lost 5.2 percent this year.
Paul Tudor Jones' whose Tudor Investment Corp. has also seen clients defect, last year told investors that he will handle a greater chunk of their money and push his managers to take on more risk. His fund is down 2.5% this year through June. And Caxton, where Law already manages most of the firm’s money, told investors that it was shifting away from a strategy called momentum. The firm has slumped 10.4% through June.
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To be sure, the pain for the industry's titans is (or may be) good news for the up and comers. Despite the current malaise, there are some bright spots. A cohort of younger managers such as Jeff Talpins and Chris Rokos have garnered billions in new investments this year, while macro funds that focus on emerging markets such as Glen Point Capital are outperforming. Alternatively, one can counter sarcastically that it is only a matter of time before central bankers flip their policies and all those who have gained YTD end up in the Bottom 20 list of HSBC's worst performing hedge funds.
Meanwhile, those who have left the industry look back on what once was, fondly. As Bloomberg concludes, Spindel remains upbeat. He’s managing his own money while putting the finishing touches to a book he’s co-written about the Federal Reserve that’s due to be published later this year. Spindel regularly rows on Washington’s Potomac River in a single scull rather than his former eight-man boat. One day he may return to managing other people’s money, he said. “I would love to be back in an eight again.”
Others, who are not quite so lucky to have had enough saved up for an optional retirement, are hardly as excited about what lies ahead.
Finally, courtesy of Bloomberg, here is a breakdown of YTD returns for some of the most prominent hedge funds.