Return Chasing – Everyone’s doing it

Return Chasing – Everyone’s doing it?
And if everyone is doing it, shouldn’t you too! Well, of course we’re being sarcastic, but the fact is, as investors, we tend to focus on those assets and/or strategies that had the strongest or weakest recent performance. We discussed this a couple of months ago, but given that this behavior is the greatest wealth destroying activity that investors engage in, it seems worthy of further discussion.

This year the fastest growing alternative strategy has been managed futures, with over $3 billion of net inflows thus far, which is roughly a 20% increase from year end. And why the growth? Not surprisingly, the category has been the best performer (by a lot) over the last 12 months. Unfortunately, investors who have allocated in the last few months might be disappointed with their returns as the strategy has had a rough go the last couple of months. This is no fault of the funds, but instead the return chasing investors who seem to miss out on large gains, invest after seeing what they missed and who then get impatient when returns stagnate or turn negative. Who knows how investors will respond to a bump in the road for a strategy they just purchased, but if history is any guide, they have very short memories and very little patience. And thus the cycle will likely continue as investors sell the underperforming strategy, buy the outperforming strategy and once again set themselves up for perpetual disappointment.

Liquid Alts Corner
The Data

Returns were mostly flat in April, with the managed futures category being the exception, as it reversed course, losing nearly 3% during the month. However, it still remains the strongest performing strategy on a 12 month basis, earning 14.5%, or 10% more than the second place finisher, long/short equity. Longer term, long/short equity still has the best 3 year performance with an annualized return of more than 6%.

Flows into the alternative space were dominated by multialternative and managed futures, as long/short equity and market neutral funds saw assets leave during April, while long/short credit was roughly flat. Multialternative funds had inflows of $2.3 billion, while managed futures brought in $800 million. Long/short equity had $350 million of net outflows, driven almost entirely by one fund that shed more than $600 million in April, bringing its trailing twelve month outflows to $13 billion. This fund has disappointed of late, but has had a strong long-term track record, which allowed it to raise a substantial amount of money in 2013. While we have no opinion on this specific fund, its trials and tribulations do reinforce our concerns about the herding behavior of investors, discussed above.

Hedge Funds In The News

(The Wall Street Journal)
Loeb vs. Buffet
As reported in The New York Times:

Mr. Loeb, who runs the $17.4 billion hedge fund Third Point, told an audience of hedge fund faithful on Wednesday that Mr. Buffett “has a lot of wisdom, but I think we need to be aware of the disconnect between his wisdom and how he behaves.”

He was taking aim at a public bet that Mr. Buffett made against the hedge fund industry, which Mr. Buffett believes cannot outperform the broader market and, specifically, the Standard & Poor’s 500-stock index.

Speaking to shareholders at an annual gathering for his company Berkshire Hathaway over the weekend, Mr. Buffett pointed out that the S&P 500 had gained 63.5 percent since 2008, while an index of hedge funds had increased by 19.6 percent over the same period.

On Wednesday, Mr. Loeb used his one-on-one interview at the SkyBridge Alternatives Conference, or SALT, to retaliate.

“I love reading Warren Buffett’s letters and I love contrasting his words with his actions,” he began. Lest anyone think it was a put-down, he quickly added, “He’s a very wise guy.”

But wise or not, Mr. Loeb had a few critical things to say about Mr. Buffett. “I love how he criticizes hedge funds, yet he had the first hedge fund,” Mr. Loeb said. “He criticizes activists, he was the first activist. He criticizes financial services companies, yet he loves to invest in them. He thinks that we should all pay taxes, yet he avoids them himself.”

To this, the audience erupted in laughter.

Every penny counts!
Paul Singer and his $25 billion dollar hedge fund firm, Elliott Management, really want their money back and every dollar counts. More than a decade ago Argentina defaulted on debt that Elliott, along with many other hedge funds, held. Since then Elliott has scoured the world trying to seize assets, including an Argentine naval ship and the country’s presidential plane. However, Elliott’s sights aren’t always set so high. Most recently the fund has been targeting two Argentine bank accounts frozen in Belgium. These accounts hold a whopping $58,000, but I guess when you are trying to collect on a $1.6 billion debt every penny counts!

Quants beware, that code is not yours
Last month we mentioned some quants that got in trouble for stealing trading model code from Two Sigma. In an unrelated case, a former Goldman Sachs programmer, Sergey Aleyikov, was convicted for a second time of stealing code when he planned on leaving Goldman to join trading firm, Teza Technologies in 2009. His first conviction for theft of trade secrets and espionage was overturned after an appeals court determined that code is not physical property and therefore he could not be charged with a federal theft statute. For more details, has a good write-up of the story.

In this month’s “How to” on liquid alternatives, we tackle how to analyze the performance of managed futures strategies. As was the case with the Global Macro category, analyzing the performance of managed futures funds is quite challenging due to the diversity of the strategies employed, and the non-constant exposure, both long and short, across one or more asset classes (i.e., stocks, bonds, commodities and currencies). Because of the lack of consistent exposure, a standard benchmark like the S&P 500 Index isn’t appropriate, but there are ways to suss out a manager’s value add.
Click here to read Evaluating Managed Futures Funds

And Lastly…
The road to success:


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