An exceptional feature of Global Investment Report’s annual survey of the Top 50 hedge funds is that it tracks the subsequent performance of the latest featured funds while discussing evolving macro and industry trends. Below is my discussion with the report’s author, Eric Uhlfelder, about his full-year findings. Click here to see the year-end study and the full-year survey. This is Eric’s 20th annual report. Learn more about the Global Investment Report here. You can find the 4Q Report here.
NilssonHedge/Linus: Eric, it is a pleasure to have you back. Congratulations on wrapping up your 20th year of surveying hedge funds Eric. In addition to your deep data dive into the world’s most consistently performing managers, your subsequent quarterly updates put your fund selection results to the test. Your 2022 crop of managers outperformed the market hugely. But in 2023 they barely outperformed Treasurys. What went wrong?
Eric: Thanks Linus. We definitely saw a reversal of fortunes between what the Top 50 did in 2022 versus what the latest group did in 2023. (Reminder: the performance in 2022 reflected the funds that were selected in 2021; and those tracked in 2023 were selected in 2022. More than two-thirds of the funds that made the previous year list have made the cut the following year (Methodology behind the selection is described on page 3 of the original 2023 survey).
To your question: I’ve been interviewing managers, allocators, and analysts to find the most compelling explanations for why so many PMs (and those in the Top 50) remained circumspect last year.
The best I can figure is that many successful managers saw little reason to rotate away from their cautious stance that had served them so well in 2022, in spite macroeconomic conditions improving with each passing quarter in 2023.
To be fair, there was strong consensus that the sharp rise in rates would trigger a cascade of problems that would metastasize. That simply didn’t happen in 2023.
The sell-off that did occur in the second half confirmed bearish sentiment. So many managers turned more negative only to get hammered when stocks soared toward the end of the year.
NilssonHedge/Linus: Why do you think managers remained skeptical, especially when the second half of 2023 was trending positive?
Eric: Several reasons. One, common belief is the rapid rise in rates in 2022 would take time before affecting economic growth and corporate profits. So far it hasn’t. Two, many mistook monetary tightening to mean a shift to a high interest-rate environment. It wasn’t. Current rates are at historically average levels. Three, managers and economists underappreciated several factors: the sustained economic boost from three major federal programs passed under President Biden, the shift in outsourcing from foreign to domestic firms to help meet just-in-time production schedules, and elevated household spending due in part to excess savings during Covid that has lasted longer than most economics expected. Let’s not forget the market rally is further fueling this virtuous cycle.
NilssonHedge/Linus: Which funds surprised you on the downside in 2023?
Eric: Here’s a list of well-established funds that had perennially made my survey but that won’t make my 2024 cut because they returned less than 5% in 2023.
- John Street Capital Systematic (2013)—Global Macro
- Schonfeld Strategic Partners (2016)—Multistrategy
- Schonfeld Fundamental Equity (2016)—Equity Long/Short
- Tudor BVI Global Macro (1986)
- Segantii Asia-Pacific Multistrategy (2007)
- Episteme (2009)—Systematic Macro
- Haidar-Jupiter (1999)—Global Macro
- Twin Tree Capital (2013)—Volatility Trading
- Arena Special Opportunities (2015)
Two things jump out from this sample list: they include a bunch of global macro and multistrategy funds.
On the macro side, the collapse of Haidar wasn’t a surprise because of how juiced Said Haidar was running his book. John Street’s decline wasn’t expected. But it’s worth noting the fund had delivered exceptional returns in 2021 and 2022, which might’ve been indicative of rising risk taking.
Multistrategy funds generally did OK, led by Citadel Wellington and Millennium. But collectively Schonfeld Strategic Partners, Hudson Bay, and Boothbay Absolute Returns underperformed short-term Treasurys. Segantii was slightly in the red and Episteme suffered one of its worst drawdowns.
NilssonHedge/Linus: Those are some really well-known names on the Macro and Multistrategy side that are disappearing from your coverage. Do you think that may mean the best days of multistrategy and macro are behind them?
Eric: Performance of most strategies, including multistrategy and macro, are somewhat cyclical. I wouldn’t write them off.
But you’ve raised the point yourself Linus that multistrategy funds have become increasingly expensive and highly competitive when it comes to talent. Both factors weigh on net returns. Even Ken Griffin suggested the strategy’s best days may be behind it.
I’m more worried about the bolt-on manager approach to multistrategy. This presents a fundamental integration problem: a compromised work culture due to muddled sense of common allegiance and purpose. (An apt analogy could be the struggles plaguing Boeing because it shifted so much work to independent outsourcing. Maybe.)
I never thought this fragmented style of fund management could produce a better and enduring investment process. We’ll see if the current spate of layoffs leads to any fundamental changes in process. I personally don’t think so.
NilssonHedge/Linus: What about your equity funds ?
Eric: The Top 50 hedged equities struggled. I don’t think this was due to minimum exposure to the Magnificent Seven as many have said. According to Forbes, the other 493 stocks in the index generated total returns of more than 10% and European and Far Eastern markets did nearly as well as the S&P. Underperformance was probably due to managers being more market neutral than materially net long.
Both Lancaster Absolute Return and MAK Capital had great 2022 returns. But Lancaster was initially stung last year in being part of the Odey fund group, which got hit by Crispin Odey’s unfortunate personal conduct. This forced its managers to significantly reduce exposure with the looming loss of it service providers. This locked in some initial declines. MAK Capital, a remarkable long-term performer, took it on the chin because the PM simply didn’t think the pain he profited from in 2022 was anywhere near over.
The second-half sell-off helped both funds rally. But they both got tagged when the market took off toward the end of the year.
NilssonHedge/Linus: Any good news to report?
Eric: Sure. Just look at the table below. These are the ten best performing funds in 2023. They ranged in strategy from emerging markets, statistical arbitrage and relative value, to hedged equity and multistrategy. Funds were as small as $600 million to as large as $43 billion. They are based in towns across the globe from Seattle to Boston, Toronto to Pfaffikon and Abu Dhabi.
This collection of familiar and little-known managers reflect the diversity and consistency of funds that comprise my survey year in and year out.
More important, they have delivered consistently decent returns over the medium- and longer-term. Nine of the ten made money in 2022–the worst performer having been down just -4.6% that year. And if you turn to the main tables in the survey, starting on page 7 of the original 2023 report, these funds have generated attractive risk-return profiles with limited correlation to the market since inception.
NilssonHedge/Linus: Rather than considering managers that are hot, you think it’s more important for investors to look at historical performance?
Eric: I think that’s the most important metric, so long as the same investment team, strategy, and process are in place. (Again, please turn to pp. 7-11 in the main report.)
Consistent long-term risk-adjusted returns that are uncorrelated to the market is the purpose of investing in hedge funds. But all hedge fund investments need to be regularly monitored. Things change, and as former US Secretary of Defense once said, “Stuff happens.” Due diligence does not end after an investment is made. It’s just getting started..
Let me circle back to previously mentioned funds that have lost their place in this year’s survey. Their exclusion doesn’t mean they’re no longer attractive funds. I maintain a strict hurdle for the purpose of maintaining a high bar to help investors target the most consistently performing managers. A decision to sell out of or invest in these funds requires a more in-depth review about what went wrong in 2023, and if underlying problems have been corrected.
But one shouldn’t give a pass even to just one year of significant underperformance. Such a stumble is one of the most meaningful indicators that something may be off.
NilssonHedge/Linus: So you would tell alternative investors to remain focused on the industry?
Eric: Yes. But doing so with great care. Keep in mind that when considering 2022 and 2023 net returns, during a bear and a bull market, we see a different picture.
In 2022, while the S&P 500 lost more than -18%, the Top 50 gained more than 9%. The market’s total annualized return over the past 24 months was 1.7%; the Top 50 added 7.1%. Over these two years, these select hedge funds delivered stronger returns with far less volatility and drawdown and limited market correlation.
Since I adopted the current methodology in 2018, this survey has continually produced the same finding when looking at trailing five-year periods and since inception.
While the composition of the Top 50 does change from year to year, more than two thirds of the funds that make the list qualify for the following year’s survey.
NilssonHedge/Linus: Thank you Eric, it has been a pleasure having you here again.