Hedge Fund Performance Shift Starts To Take Shape

A hedge fund performance shift is beginning to take shape, as the second place spot on the HSBC Hedge Weekly performance list is now a long/short hedge fund player and managed futures CTAs that dominated last week slip down or off the performance list. The number two fund manager in second place, John Burbank’s $550 million Passport Special Opportunities Fund, however, is a rarity in the category. With this in mind, how does a long/short portfolio manager generate noncorrelated performance? At Lazard, both a managing director in portfolio advisory and separately a long/short portfolio manager provide ValueWalk readers insight. 

Hedge fund performance shift

Hedge fund performance shift begins as managed futures performance leaders from last week knocked down or off the performance list,

Last week, ValueWalk noted the potential for a hedge fund performance shift to take place. On this week’s performance list, short term mean reversion player Roy G. Niederhoffer’s Diversified Offshore fund, which was up 14.52% last week and in third place, one week later is reporting 8.70% year to date positive returns and is 12th place. Managed futures CTAs and other quantitative players knocked off the list include Crabel Fund, Welton Global Directional Portfolio, Two Sigma Compass, Eagle Quantitative Macro and Millburn Diversified Program.

Many of the quantitative hedge funds should be expected to experience challenging situations when beta market environments change direction. As noted in ValueWalk, significant changes in commodity, currency and stock markets have been causing short term problems. This, however, might bring opportunity in the future for such programs.

Managed futures CTAs nonetheless represent some of the best performers of all hedge fund strategies thus far. The HSBC Managed Futures Currency / Global category, for instance, is up 3.17% year to date. The Systematic / Global category, which contains many of the largest funds, is up 2.70% year to date.

Hedge fund performance shift

A quandary in 2015 and 2016 has been the lack of performance of relative value, long / short strategy category.  The HSBC Equity Long / Short Diversified / Global category is down -3.76% year to date and the Diversified / USA category is down -4.06% year to date.

In many cases the performance drag, a hedge fund performance shift, often occurs in the short leg of the portfolio, but one long / short strategy that has been as successful short as they have been long is the Lazard Fundamental Long / Short Portfolio, which offers their alternative investments via a mutual fund. The strategy plays into a need at this moment in history, when institutional managers are taking a hard look at their traditional methodologies.

As Jamie Schachtel, Managing Director of Lazard’s Capital Advisory Group, scans the world of asset allocators, he notices a distinct change from the long-only focus of the past. Among portfolio managers at family offices, foundations and RIAs there is a quest for “a different approach in a world were increasing volatility and valuations call into question traditional approaches,” he told ValueWalk in an interview.

When evaluating a long/short strategy, Schachtel said professionals he speaks with, many of whom are dissatisfied with traditional portfolio management techniques, like to focus on correlation analysis, downside capture statistics and understand the portfolio method at a basic level to determine if the process is repeatable.

In this environment a long/short equity strategy such as the Lazard Fundamental Long/Short Portfolio strategy comes into play. When the S&P 500 (measured by the SPX) was down 6.26% in August of 2015 and off 2.64% in September, Lazard’s U.S. focused long/short offering was down only -2.46% in August and up 1.22% in September. While the SPX finished the year -1.75%, the Lazard fund was up 5.97%.

Long/short portfolio management focuses on short exposure winners and risk

For Lazard portfolio manager Dmitri Batsev it is about discipline in both long and short opportunity selection and a risk management process. The fund has a tight long/short ratio of 84.2% to -55.1% respectively, for a net long of 29.1% — a much tighter differential between long and short exposure than the traditional long weighted firm.

The fund does not necessarily focus on the ratio management, per say, but the tight range is a matter of opportunity: the fund focuses on short stock selection that can make money in up stock markets. Both their long and short returns attributions show nearly an even 300 basis point lead over the stock market benchmark, showing equal alpha on both sides of the equation. This is a key point in evaluating a long / short program.

The key to success both long and short, says Batsev, is stock selection. When considering a long or short opportunity, they model a base case, bull case and bear case. If their is significant dispersion of potential outcomes, they reduce allocation percentage, but increase it when the range of expectations shows tighter dispersion.

The fund uses a risk management overlay but does not adjust long/short ratios based on a macro market outlook. “Making macro market calls, predicting market direction, is difficult and not often repeatable,” Batsev said. The somewhat systematic risk management process will consider reducing exposure in a position if it results in a 50 basis point loss to the portfolio and will eliminate exposure if it results in a net 100 basis point loss.