‘Shutdown The Book’.

I’ve been meaning to pen a quick update on hedge fund performance in November for two days now, and I’m finally getting around to it.

We’ve spent what might very fairly be described as an inordinate amount of time covering the recent trials and tribulations of the fundamental/discretionary crowd following the October equity rout and ongoing volatility/market chop in November/December.

The problem, just to quickly recap, is that the Long/Short crowd looks to have taken up their exposure to a record high in September (at least on a simple moving beta of the HFRX Equity Hedge index to the S&P) on the eve of the correction. That grab for exposure presumably came courtesy of benchmarks running out ahead of active management in August, when U.S. stocks pushed to new record highs in an environment where hedge funds hadn’t rebuilt their exposure post-February selloff. Here’s the chart again:

(Bloomberg)

That purple arrow over there on the right appears to suggest that hedge funds were gingerly getting back in after low-ticking their beta to equities early last month and needless to say, it’s been a challenging environment.

Wild intraday swings and unpredictable headlines around trade and domestic politics have made an already tough year worse and at this juncture, it’s probably too late to salvage anything.

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Pondering Hedge Funds In The New Market Zeitgeist

“The inability to hold rallies with the year-end timing and the performance realities continues to dis-incentivize pursuit of higher US Equities over the next three weeks”, Nomura’s Charlie McElligott wrote on Wednesday.

Wells Fargo’s Chris Harvey had some good color on this in a note dated December 5. Here are a couple of excerpts:

In October and November, the pain behind the screens (portfolios) felt like it was 2-3x of the pain on the screens (stock market). By the end of Nov’18, de-risking was so widespread it seemed like there was no one left to de-risk. In early October we wrote that selling of Tech & Momentum stocks would beget selling, but the voracity and the collateral damage was exceptional even to us. We think the voracity was a function of Behavioral Finance at its best. During the sell-off, career risk became elevated and drove, at times, indiscriminate risk selling and not always the most optimal executions. To be fair, a number of PMs had no choice as VARs or stops were violated or worse, the dreaded tap on the shoulder (shutdown the book).

Fun times! So where does that leave things? Well, Harvey elaborates a bit further in an effort to answer that question. “Large Cap Fundamental funds in our universe, which had been outpacing their benchmark until Oct’18, are trailing their bogey by -84bps”, he says, adding that if you ask Wells, “this group has a shot to get back to flat vs. their benchmark but with weeks left in 2018, it’s a footrace [as] during Oct/Nov, the group lost as much as 210bps of relative performance.”

(Wells Fargo)

In the same vein, Bloomberg’s Hedge Fund database shows equity funds posting the worst performance of all strategies in November, falling 0.73% for the month. “Portfolio managers are being stymied by an array of challenges, most notably churning volatility driven by U.S. political and economic concerns”, Alan Mirabella wrote earlier this week. Here’s the actual breakdown:

(Bloomberg)

Is there any good news in all of this? Yes. The good news is: 2018 is almost over and once the calendar flips, folks can stop playing defense.

“I expect January to see the larger attempt to push Equities tactically higher with funds no longer PNL- / VaR- constrained and needing to play offense especially in light of the positive movement on China trade (with a potential heavy ‘leak’ period from both sides during the ongoing negotiations) and the recently destroyed valuations (Cyclicals pricing-in outright recession) seeing investors nibble on their high conviction favorites again”, the above-mentioned McElligott wrote, in the same Wednesday note.

For the time being, year-end can’t come fast enough. The HFRX Equity Hedge index is down five months in a row and December looks really – really – bad so far.

(Bloomberg)