Column: Volatility, leverage dominate Miami hedge fund week

Jan 30, 2020; Miami, Florida, USA; General overall view of palm trees and the downtown Miami skyline. Mandatory Credit: Kirby Lee-USA TODAY Sports

MIAMI, Jan 27 (Reuters) – Swanky resorts, expensive hotels, and even more expensive cars – the familiar trappings of the vast wealth controlled by the thousand-plus delegates descending on Miami this week for a trio of conferences known as ‘hedge fund week’ were on display.

There were plenty of smiles on show too, but a few of them will have been forced. While hedge funds claim to thrive on volatility, they have not escaped the recent market churn and amid the deal-making and back-slapping, nervous talk of losses abounded.

Some funds are down anywhere between 5% and 20% year-to-date and at least one big name is getting ‘smoked,’ according to one manager, and many have been ‘crushed,’ according to one long-short equity specialist.

Granted, they may be the more extreme examples of the challenging start to the year money managers are experiencing.

Data from Morgan Stanley, which works with the world’s biggest and most powerful hedge funds, show that global hedge funds were off some 3% in the first three weeks of January and long-short U.S. equity funds were down some 6%, according to a source with direct knowledge of the research. read more

That’s not quite as drastic.

Losses of that magnitude at the end of January, however, would still represent a historically bad month.

The source of all this angst, of course, is the eye-popping shift in U.S. interest rate expectations since the turn of the year. The Fed on Wednesday signaled it will deliver on these hawkish expectations that have roiled Wall Street, hammered tech stocks, and lit a fuse under volatility.

Funds with higher leverage are most vulnerable.

“What I would be careful of is returns that are based more on leverage than are based on the investment. Be careful of funds that are levered. Look at unlevered returns,” billionaire investor and Avenue Capital Group’s Marc Lasry told a panel.

“We are keen on not using financial leverage to generate returns,” David Weeks, chief investment officer at LMCG Investments, said on another.

SEEK AND YE SHALL FIND

Depending on your interpretation and the strategy in question, hedge funds had a bad year last year. In broad terms, they returned 10%, according to industry data provider HFR, well below the S&P 500’s total returns of around 28%.

Within that, macro funds returned even less, while commodity strategies and energy funds outperformed. The anecdotal evidence at hedge fund week suggests January will be a bruising month across the board.

Even if the Fed tightens monetary policy less than the 100-plus basis points markets currently expect this year, the era of near-unlimited, zero cost liquidity appears to be ending.

So while many here boasted of their desire to make alpha, they also stressed the need for capital preservation. As Ruffer LLP’s Alex Lennard put it, bond and equity markets have not been this sensitive to higher interest rates for decades.

“The set-up is not great, and in particular the lack of protection means … that moves can be gap-prone. We are moving to an environment of much more macro volatility,” he told Reuters.

Ah, volatility again. It should be jet fuel for hedge funds, who pounce on price mismatches and anomalies, and go where more risk-averse investors fear to tread. It’s when volatility turns to illiquidity that it threatens to blow up in funds’ faces. That line can be blurred and difficult to discern.

Reflecting the widespread desire for new means of generating returns, several panels were dedicated to all aspects of cryptocurrencies, digital assets, and blockchain technologies.

High-profile advocates like Galaxy Digital’s Michael Novogratz and SkyBridge Capital’s Anthony Scaramucci preached the word, and estimates of the crypto universe’s value in five years’ time from one panel ran into the tens of trillions of dollars (it is currently around $1.7 trillion).

But money-spinning openings in good old-fashioned assets also abound, even if high valuations in domestic markets mean U.S. managers may have to venture a bit further afield.

Greek banks, Chinese property sector bonds, and Mexico’s Pemex-sovereign debt spread, anyone? These are some of the areas that Steven Tananbaum, billionaire chief investment officer at GoldenTree Asset Management, is looking at.

“I see a lot of opportunities. They’re always out there, you just got to find them,” he said.

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever; Editing by Andrea Ricci

Our Standards: The Thomson Reuters Trust Principles.