What the fourth quarter of last year lacked, the first quarter more than made up for, as evidenced by the impressive returns many hedge funds managed for the first quarter. In their first-quarter letter to investors, which was reviewed by ValueWalk, Evanston Capital Management describes the quarter “largely a mirror image of the end of 2018 for most risk assets”.

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That ended up being an outstanding environment for long/ short equity funds, which drove the firm’s Weatherlow portfolio’s strong returns.

Market rally drove strong returns for most managers

Most stocks soared during the first quarter, with many more than recovering their Q4 losses, and credit spreads generally tightened. The only asset class which didn't revert during Q1 was government bonds, which rallied on the back of the Federal Reserve's dovish tilt. The yield curve kept flattening, while the 10-year and two-year spread tightened from 19 basis points to 14.

Evanston Capital's Weatherlow fund of funds was up 6.3% for the first quarter, outperforming the HFRI Fund of Funds Composite Index's 4.6% gain in the quarter. Weatherlow has stakes in a lot of very high-profile funds, and many of these funds produced strong, double-digit returns for the first quarter. Long/ short equity was the outstanding strategy for the first quarter, another reversion of what we saw in Q4. In addition to long/ short equity, event-driven and global asset allocation funds also saw positive returns.

The team didn't change the Weatherlow portfolio's holdings other than some small shifts in weights due to rebalancing. The portfolio remains concentrated with 20 core managers and about 24% of it in the top five positions.

Long/ short equity outperformed in Q1

Although the equity rally was broad-based, the Evanston team said major indices didn't recover all of their losses. Since the end of September, the S&P 500 is down 2%, while the Russell 2000 is down 9% and the Nasdaq is down 3%. The EuroSTOXX is down 1% since then, and the MSCI Asia Pacific is down 2%. The only index with a positive six-month return was the MSCI EM index, which returned 2%, according to the Evanston team. The one especially bright area was real estate, which is up 13% since the end of September.

"The equity rally began during the last week of December when it simply seemed that there were no sellers left," the Evanston team wrote. "Most of the Fund’s equity long/short managers identified the December sell-off as predominantly a sentiment and technical-driven deleveraging event that was unrelated to underlying fundamentals. In response, these fundamental stock-pickers largely stayed the course and did not dramatically change portfolio exposures."

The firm confirmed something we saw in most of the Q4 hedge fund letters we reviewed. Most long/ short equity funds used the weakness to add to positions they held strong convictions in and add new positions at "suddenly attractive entry points."

"The result was that many managers posted strong returns in the first quarter," the Evanston team wrote.

Weatherlow's best-performing funds

The largest holding in the Weatherlow portfolio is the Element Capital U.S. Feeder Fund, according to the firm's first-quarter letter. Element returned 5.1% during the first quarter.

Weatherlow's best-performing fund was 12 West Capital Management, with its extremely impressive 30.8% Q1 gain. The Evanston Capital team said 12 West more than regained Q4's losses and is now up 8% since the end of September. 12 West's top three positions soared 54%, 30% and 15% during the first quarter, which further demonstrates the gains long/ short equity managers were able to recapture by holding on when the market dropped suddenly.

The other two top-performing funds were Salthill Partners, with a 21.3% gain, and Oxbow Fund, with its 19.3% gain. Salthill is a dedicated biotech specialist, and it rebounded strongly in Q1 after the weakness it recorded in 2018. Evanston cited the biotech rally and the "active takeover environment" for Salthill's first-quarter strength.

Other funds which posted double-digit returns for the first quarter include Pelham Global Financials Fund, Long Pond Capital QP Fund, Sachem Head, Matrix Capital Management and Whale Rock Flagship Fund. Whale Rock and Matrix held lower gross exposures than in previous quarters. Matrix slashed its gross exposure as Q1 went on, taking profits in a long-term software stock which had nearly doubled and by reducing portfolio concentration. Whale Rock also reduced its portfolio concentration, and its returns were driven by its long book. Payment processing, internet commerce, and emerging software boosted the fund's portfolio.

The Evanston team also highlighted Teton Capital, which was its newest addition. Teton gained 9% during Q1 from a "balanced distribution of U.S. and international stocks." The fund has also made a name for itself with its exposure to Korea, and its position in a Korean furniture and appliance manufacturer rallied strongly during the quarter. Teton also benefited from a number of positions in online real estate.

Other honorable mentions include Two Creeks, which gained 9% during Q1, mostly from its long portfolio but also on the short side late in the quarter. Two Creeks has been focused on short-selling in recent focus, and the volatile environment has given its short strategies a boost. Among the successful short themes Two Creeks has benefited from are grocers, which are being encroached upon by Target and Whole Foods owner Amazon, and paper companies. Two Creeks' long portfolio benefited from multiple sectors and themes, led by payment processors, software, consumer and Indian banks.

Weatherlow's weakest funds

The only fund which returned a double-digit negative performance during the first quarter was Iconic Volatility Arbitrage Fund with its -26.7% return for the first three months of the year. The Evanston team explained that "the volatility expansion of late last year quickly reversed amidst the return of animal spirits."

The sudden dovish turn from the Fed which benefited most other managers took a massive bite out of Iconic's returns during the quarter by "crush[ing] U.S. rate volatility across the curve." "Ill-timed tactical moves and a handful of suboptimal trade-structuring decisions" further increased the pain for this fund

The other funds that were negative for the quarter were Pleiad Asia Onshore Feeder Fund and Anchorage Capital Partners. The rest of the funds included in Weatherlow's portfolio were in the green for the quarter. The Evanston team said although the asymmetry "should be attractive," they are "evaluating Iconic closely given some of the execution missteps in recent quarters."

In general, the fund's credit managers had a somewhat difficult quarter despite the strong rally in the credit market. Marblegate gained 1%, and the Evanston team explained that the fund's "process-oriented approach in the middle market" means that its results are usually "driven by idiosyncratic news and events."

Anchorage was flat for the quarter after gains from a pet supply retail chain and its long performing credit book were offset by losses in the short book. Anchorage did rotate out of some of those problematic short themes during the first quarter.