38.5% through CY14, hedge funds have found themselves broadly underwater remaining long our preferred exposures in the Hedgeye 2013 Macro Playbook and short our least-liked ones. The key issue with that is that it’s 2014, not 2013. Macro markets have been front-running a cessation of our #StrongDollar + #RatesRising = #StrongAmerica view since JAN.
To recap hedge fund performance:
- HFRX Equity Hedge Fund Index: -166bps MTD, -306bps QTD and -185bps YTD
- HFRX Macro/CTA Index: -57bps MTD, -113bps QTD and -216bps YTD
Obviously, we have number of hedge fund customers, so we don’t write this to be trite or disrespectful. We only call this to your attention because if this trend of poor performance continues, there will likely be an industry-wide lowering of gross exposures and tightening of net exposures, with capital outflows as a key tail risk.
With the exception of a handful of very astute investors (and an independent research firm domiciled in CT), it’s become increasingly clear through monitoring performance and collecting anecdotes that the majority of the hedge fund space came into 2014 with basically the same exposures:
- LONG BOOK: US equities – particularly the growth style factor(s) and Japanese equities.
- SHORT BOOK: US Treasury bonds, long-duration credit, everything-EM, commodities and the Japanese yen.
A subtle, but important callout here is that with the exception of a handful of very astute investors (and an independent research firm domiciled in CT), not everyone nailed front-running all of these major macro moves in 2013 (e.g. HFRX Macro/CTA Index down -1.8% in 2013 vs. S&P 500 Index up +29.6%). That means there’s likely a fair amount of funds that jammed into the 2013 playbook at precisely the wrong time (i.e. just in time for CY13 “window dressing”).
The key risk here for investors to manage is that the longer 2013’s losers (i.e. the aforementioned SHORT BOOK) continue to exhibit higher degrees of relative momentum on a trending basis, the greater risk there is to the upside, given the crowded nature of these trades and the propensity for investors to unwind such underwater exposures at roughly same time – likely on the same catalyst(s).
Our TACRM All-Weather System continues to signal rotation-based flows into Fixed Income & Yield Chasing and EM Equities as primary asset classes, in lieu of DM Equities, at the margins:
This is a direct function of the relative momentum taking place at the secondary asset class level – which is more-or-less a 180° flip from 2013:
For more details on how to interpret these charts, please review the following presentation: http://docs.hedgeye.com/HE_TACRM_2014.pdf. Email us if you’re interested in how TACRM can beef up your research and risk management processes; we are happy to customize it to your watch list.
Going back to the aforementioned point regarding the rotation in Fixed Income & Yield Chasing and EM Equities, we encourage you to review the following two research notes:
- CHART OF THE DAY, MAYBE OF THE YEAR? (5/16): TAIL risk is on (to the upside) in the bond market and we think investors should react accordingly.
- DOES THE EM RELIEF RALLY HAVE LEGS? (3/26): We are inclined to believe the current relief rally across EM capital and currency markets has legs w/ respect to the intermediate term.
If a trip to Quad #3 on our GIP model is not “the catalyst” mentioned above, then we too are still searching for that “ah ha” moment.
Even without a catalyst, the risk that fund managers are broadly forced to sell 2013’s winners in order to finance an industry-wide performance chase in 2014’s winners is not inconsequential. That would roughly equate to investors broadly flipping their entire exposures (and thesis) on its head, so we’re comfortable with our anecdotal evidence that most people have yet to do so.
In fact, our conversations with some customers and prospective customers have gone a lot like this:
- Hedgeye Macro Team: “We continue to like bonds, slow-growth/yield chasing stocks like Utes and REITs, commodities and emerging markets in lieu of things like US and Japanese equities and the US dollar.”
- Investor: “Nice call. I hear ya, but I can’t justify buying Utilities up here. They are so expensive now. I feel like the money has already been made.”
- Hedgeye Macro Team: “Ok, that’s fair. You know how we feel about valuation not being a catalyst, but, at a bare minimum, don’t be short these markets. The risk in these asset classes is up, not down, given the consensus lean in the hedge fund community.”
- Investor: “Got it; thanks.”
If we had this conversation 10 times in the past week, we’ve had it 1,000 times since FEB. Make this the 1,001th time.
Have a great evening,
Associate: Macro Team