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Picking hedge fund winners turns harder for investors

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Investors are returning to hedge funds after the sector posted its biggest gains in a decade in a topsy-turvy 2020. But picking which managers will do well this year will not be straightforward.

Having fallen out of love with hedge funds’ sluggish returns during the bull market of recent years, some investors are being drawn back by what some commentators claim is one of the sector’s best years. Clients have been impressed that many funds have been unscathed by the Covid-19 pandemic and its market volatility. Some 45 per cent of investors surveyed recently by the Alternative Investment Management Association and research house HFM plan to increase exposure to hedge funds.

The problem, however, comes when investors have to decide which funds to put their money in. Far more than in most years, being in the right place at exactly the right time in 2020 really determined a manager’s fortunes, rather than an ability to dissect a balance sheet and build a pricing model.

In a rollercoaster year, funds had to face the S&P 500’s fastest descent into a bear market and an eye-watering rebound, as well as the outperformance of expensive stocks with faster growth prospects than more lowly valued stocks.

Whether a fund timed those waves precisely or not has gone a long way in determining whether its managers have been celebrating their biggest bonus or watching their painstakingly-built record being torn to shreds. The gap between the top and bottom-performing hedge funds opened up to its biggest since 2009, according to data group HFR.

For instance, buying Tesla in late 2019 — as Boston-based Whale Rock Capital did — clearly looks like a great decision in hindsight, even though all but the most ardent Elon Musk fans may not have predicted a 743 per cent rise in its share price last year. Whale Rock went on to chalk up a 71 per cent gain in its long-short fund. Conversely, if you had focused on buying cheap stocks, even the world’s best stockpicker would have faced the headwind of a 23 per cent underperformance of the Russell 2000 Value index compared with the Russell 2000 Growth index.

“It’s definitely harder to assess skill at the moment,” said Bruce Harington, head of long-short strategies at Stenham Asset Management, which invests in hedge funds.

With markets moving so quickly, the vagaries of market timing mattered. Take London-based Helikon Investments. After leaving Kairos Investment Management at the end of September, founding partner Federico Riggio wanted to launch his fund as soon as his six-month non-compete clause expired. This produced a launch date of April 1, just over a week after the S&P hit a three-year low — surely one of the most fortuitous times to launch a fund in recent memory. While the firm correctly called the revival in stocks, Mr Riggio admits the timing of the launch also helped. “We were lucky,” he said.

And what should investors make of the awful year some of the hedge fund industry’s most experienced figures had? CQS founder Michael Hintze was for years viewed as one of the top credit traders with a record of double-digit gains before suffering a shock $1.4bn loss last year. 

Analysing why managers lost money and whether they can turn it round becomes even tougher for quantitative funds, many of which are viewed as black boxes by investors. Jim Simons’ Renaissance Technologies, possibly the industry’s best brand name, suffered double-digit losses in some funds. Even Winton Group’s David Harding, whose flagship fund suffered its worst year on record, told the Financial Times last year there was “not any single reason we’re doing badly”.

Differentiating between a manager’s skill and luck is an age-old problem. Industry veteran Dixon Boardman is among those who believe genuinely skilful managers will eventually come good, even if they have had a very tough 2020.

“Can clever people become stupid overnight? Obviously not,” says the chief executive of Optima Asset Management. “Will good managers make out in the end? Absolutely.”

Investors who pay funds’ high fees can argue with some justification that it is the manager’s job to navigate markets, whatever the conditions.

But the danger for investors is that picking a manager could easily become more about a call on markets, on value versus growth investing, or even on the future share price of Tesla. More than ever, recent past performance is unlikely to be a reliable indicator of future returns.

laurence.fletcher@ft.com



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European stocks stabilise ahead of US inflation data

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European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.



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Potash/grains: prices out of sync with fundamentals

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The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

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Amazon sets records in $18.5bn bond issue

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Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.



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