Global Investment Report’s survey of the Top 50 hedge funds is unique industry research. This year is the 20th edition of the survey, which previously has been featured in The Wall Street Journal, Barron’s, FinancialTimes, and Institutional Investor. An exceptional feature of the annual survey: it then tracks the subsequent performance of the select 50 funds while discussing evolving industry trends.
I had the opportunity to sit down again with Eric Uhlfelder, the author of the report, to discuss his mid-year update of his global survey. We discussed recent performance and more specifically the underwhelming results delivered by several large and smaller managers.
If you want to skip our chat, you can jump directly to his report by opening this link where there are more insights into recent performance. And you can learn more about Eric’s work at Global Investment Report.
It’s been a challenging first half year for most hedge funds. In your Mid-Year Update, you noted modest returns through June for the funds that qualified for your survey. What is your take on this lackluster performance?
No question I was surprised to see the anemic first-half performance of the 50 most consistent broad-strategy funds, which were up an average of just 1.1%. They trailed the market by 15 percentage points. The main reason: these managers didn’t buy into the rally.
While that performance gap was uncharacteristically large, consistent funds will always trail a bull market, normally delivering decent absolute returns during such times. That’s in their DNA. They prove their medium and long-term advantage by outpacing markets when they turn bearish. We’ll need to see what the rest of the year brings to discern whether these managers were prescient or just wrong about the market.
On the slightly positive side, two-thirds of the group was up, generating average returns of 4.6%. Emerging market and arbitrage funds were the top performers with gains of more than 6%.
We have recently seen a fair amount of criticism against the multi-strategy/multi-PM hedge fund model. The FT called it the end of a golden era. Last year we saw increasingly restrictive investor terms and longer lockups for several large funds. In your view, how much of the criticism relates to the model and how much is simple investor frustration with significant market underperformance coupled with more costly terms?
The 10 Top 50 funds that are multistrategy delivered modest first-half returns, gaining just 2.4%. The average multistrat, according to BarclayHedge, gained less than 1% during the same time.
Without having access to actual portfolios, we can’t pinpoint the precise reasons why these funds drastically trailed the market. Piecing together what various sources (including managers) told me, it’s pretty clear multistrategy managers, like the rest of the industry, remained cautious.
This posture had served them exceedingly well in 2022. Last year’s multistrategy funds that made the Top 50 (the same managers that comprised this year’s list) delivered gains of more than 10%. That was 28 percentage points better than the market.
With a huge equity market performance swing between last year and this year, very few managers will excel over both periods. It just isn’t possible, which largely explains the performance dichotomy we’re seeing. Pundits and journalists are generally near-term focused and don’t report this larger picture.
To your point about added expenses holding back returns, let’s look at the top 3 multistrategy funds on the Top 50 list. Third-ranked Citadel Wellington led the pack up 7.15%; 11th-ranked DE Shaw Composite rose 4.26%; and 19th-ranked Millennium was up just 2.84%. Higher fees and costs alone can’t explain this significant underperformance compared to the market.
The FT article you cited discussed several distinct trends in multistrategy investing. Two things stood out.
Goldman Sach found that while the strategy holds only 8% of hedge fund assets, they account for 27% of the industry’s exposure —the difference being leverage. The group also represents more than one-quarter of the industry’s headcount. Ken Griffin’s takeaway is likely spot on: “Clearly right now multistrategy managers are very much in vogue. When you’re most popular is probably when you’re reaching the top of the cycle.” These observations suggest two unfavorable trends: rising costs and a strategy potentially running out of capacity. But the latter doesn’t occur overnight. It could simply mean, like most other hedge fund strategies, they’ve made a conscious choice not to partake in the market rally.
The counterpoint here is that low equity exposure simply was good risk management. Are there good arguments to be made there? The Eurozone is balancing on the edge of recession, but going into September equity markets don’t seem to care. The gap between equity prices and fundamentals has been widening.
You point to the conundrum facing every manager: follow the crowd or mind the gap you cited? Even some of the most bearish managers are probably considering rotating toward some middle ground. Patrick Ghali, a managing partner at the consultancy Sussex Partners, told me: “It’s unclear whether (his favorite managers) are behind the market or well ahead of the volatility that’s to come.” His firm has since rotated from its zero-equity position towards a 20% exposure. But that exposure is in idiosyncratic small- and mid-cap stocks involving short-term, lower-risk trades. That sounds like a reasonable compromise.
Let’s take a slightly longer-term view of how managers address risk. In early 2020 when we’re facing economies shutting down with little clarity about how profound the pandemic would be, managers held their ground and enjoyed the second-half rally.
This year, fearing the impact of interest rates returning to normal levels, managers felt the sky would be falling. Maybe they relied on the historical record of market performance when rates rose. In contrast, there was no precedence to inform the fallout of the pandemic—which to me looked like a far greater risk.
Some of the winners from last year, global macro funds that implemented the short bond trade in size, are suffering this year. During the short-lived banking crisis of March 2023, bond markets staged a strong reversal, leading to losses for some of the high-profile global macro names, but also for their systematic peers. Did this take the oomph out of the investor sentiment toward macro and managed futures strategies?
I don’t think that was a primary cause of macro managers’ struggles. Let’s look back over the past 18 months.
Last year was set to see strong macro trends, which likely made it easier for macro managers to pile into certain trades. Having been recklessly slow to move rates from ultra-low Covid-emergency levels after the pandemic had clearly eased, central banks were forced to play catch up.
Rose-colored thinking in the middle of last year suggested a pivot toward rate cutting was in the offing. No way was that going to happen. Being roundly criticized for their complacency, central banks needed to be seen as hawkish to reestablish their credibility. Even now, this likely means they won’t be taking steps to preempt recession.
In addition to attractive bond shorts, strong monetary trends set up more robust currency trading opportunities than we have seen in quite some time.
Last year’s stock market slide was also fairly predictable. Remember, we had a monster 4Q21 rally (in the US) that made no sense with inflation taking off, soaring energy costs, extant supply chain issues, the pandemic still with us, and Russia poised for war. There were many good reasons for having been short stock indices.
But in 2023, the only definitive trend is one that many managers didn’t trust—rising equities. So perhaps it’s not particularly surprising to see macro and managed futures struggle.
The “Tiger-cubs” suffered greatly during 2022 due to increasing concerns about high-growth companies to which they were exposed. This year we have seen the cubs recover some of their losses. However, Bloomberg reported that investor appetite has been fairly muted for these “former” stars. Among the funds you cover, is there a tendency for past winners to turn into future losers and past losers to turn into future winners?
Remember, to qualify for The Top 50, a manager needs to show consistent absolute returns over the trailing five years. So, if a fund has an off year, it will take some time for it to again qualify for inclusion.
But your point about past winners going south: absolutely. And they are predictable. I caution readers each year especially about the highest-ranked funds. And that prediction is hardly neuroscience. Whenever funds generate 25%+ annualized returns for the trailing five years, that’s a run that’s very hard to sustain regardless of market conditions.
I’ll provide several examples from my past three surveys.
Sosin Partners is a small, high-conviction, concentrated equity long-bias fund who saw risk management primarily in its long stock selection. It didn’t really hedge. The fund took the top spot in the 2020 survey with 5-year annualized returns of more than 31% through 2019. Then in 2020, it gained more than 96%. One of its core holdings—Carvana—benefitted hugely from the pandemic. This boosted its trailing 5-year trailing annualized returns to more than 46%, helping the fund to easily retain the No. 1 ranking.
While the market climbed nearly 29% in 2021, Sosin ended the year up just 3.9%. That was below the minimum hurdle to qualify for the 2022 Top 50 list. Despite its companies’ changing fortunes, the manager maintained his holdings and long bias.
Sosin collapsed by -77% in 2022.
That same year was the first time Skye Global qualified for the survey. It had just passed the survey’s minimum of five years in business with eye-popping trailing returns of nearly 50%. The hedged equity fund had become a Wall Street darling with record capital raising that helped boost assets to more than $5 billion.
But Skye Global lost more than –47% in 2022.
This year’s 2023 survey was led by global macro manager Haidar Jupiter. This consistently performing fund has been around for more than 23 years. But over the previous two years, manager Said Haidar had clearly became more aggressive, pushing up leverage and making large one-sided investments that helped it generate annual returns of 70% in 2021 and then 193% in 2022. This produced 5-year trailing numbers through 2022 of 55%.
It then lost nearly -30% during the first half of 2023. But the fund had been struggling since the end of 3Q22, having lost -29% in the final quarter of 2022.
Consistency doesn’t guarantee future performance. But as a rule, the most reliable managers generate annual returns that tend to be range-bound between high single-digits and low double-digits. They stay true to a disciplined, repeatable investment process which gives them a greater chance of generating similar forward returns—regardless of strategy and market conditions.
Thanks Eric, it is always great to get your views. Click here to explore the Global Investment Report or here to read the latest H1-2023 edition.
Photo credit: Carin Drechsler-Marx
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