Here is a way to start an article like no other; what a fantastic year 2020 has been. The obituary of the hedge fund industry has been written many times, but for some, it was written in indelible ink in 2008 following the financial crisis. Commentators blamed the industry for its part in the global collapse, notwithstanding the fact that a huge majority of fund vehicles during that time were actually victims themselves. Ignoring the huge layer of red tape that subsequently encased the industry, this wasn’t actually the largest cause for concern.
The bigger problem was that once the S&P settled down, its solid and consistent performance led to a benchmark that the industry simply couldn’t match. Many funds struggled to provide the exceptional returns they were once capable of and with new products like exchange-traded funds combining performance with a lower risk profile and lower fees, the glitz and glamour of AW Jones’ product had truly been eroded. However, the inflow of investment remained, and while the lack of true performance caused general resentment, a shock to the global financial system might cause the passive investment models to fail and suddenly the two and 20 would look like money well spent. So the script for 2020 couldn’t have been better written by Hollywood, although probably would have had a little more Dwayne Johnson. The flash crash in March could have lead to the industry flourishing from that point forward.
Sadly, a record 150 funds were classed as poor performers in the "Spot the Dog" list compiled by wealth manager Tilney Bestinvest, which names and shames the worst-performing investment funds and reported a 65 per cent increase in the number of "dog" funds, up from 91 in February. Interestingly, this is consistent with the tough time value investors have generally had over the last decade. Buying shares in companies which appear cheap given their fundamentals became a true art form, but the markets simply haven’t played to the same rule book and one obvious explanation for this is the rise of tech firms, which are simply impossible to analyse using standard valuation tools. Brand strength and user adoption models seemingly become far more important than the profit line, for example. With a pandemic forcing the entire planet to go online simultaneously, the arguably overvalued tech stocks somehow continued to grow exponentially. Those companies that remained well placed to increase in value consistently if the world had continued on its "normal" course, suddenly found that the very solid foundations they were sensibly built on were destroyed from under them. Hugely dependable industries were decimated in a matter of months which even the very best minds in the hedge fund industry couldn’t readjust to quickly enough. Where you have such a fundamental and novel shock to the system, the largest funds will always have the biggest problem with turning their tanker around. Just looking at the Top 20 Dogs, all but one of them is over a billion and you can see some truly institutional names. On a wider basis, the ten largest hedge funds reporting to eVestment remain some 4.61 per cent in the red year-to-date, despite posting a 1.31 per cent gain in July. In contrast, hedge funds overall are now flat for the year, having registered a 3.43 per cent rise in July to successfully claw back losses suffered in H1. Market neutrality achieved? Being nimble and able to pivot in this type of market was always going to be advantageous.
From our own anecdotal evidence, given we have the pleasure of working with a large number of emerging managers, we certainly have clients who are putting some very significant numbers up on the board this year. It has been especially noticeable in the digital asset slice of this market. Whether you believe in the digital gold theory of bitcoin or not, there is no doubt that with so much uncertainty out there, investors are looking for interesting alternatives to find value and it is no coincidence to see another rise in real estate focused funds as well. It is entirely unfair to judge anyone in any industry on their performance this year, save for those that have craved volatility to demonstrate their worth. However, I think we have to let the year play out before making any sweeping judgements, but that makes the next Spot the Dog report all the more intriguing. Popcorn at the ready.
This article was originally published by Citywire Wealth Manager.