The T Report: Some Numbers Worth Thinking About

What Are Investors Thinking About Coming Into the Home Stretch?

Whether it is right or wrong, many still think of investing on a calendar year basis. So as we crawl through this period of incredibly low volatility and low volume it is time to start thinking about the home stretch. Coming into year end there are some striking numbers that investors and money managers must be thinking of and are likely to influence their decisions for here on out.

Equities

The S&P 500 is up 11.8% for the year. The Nasdaq is up 16.3%. Had you been lazy and just bought AAPL (which is allegedly the most owned stock by hedge funds), you would be up 55.8%. Had you “tried to lose client money” by buying banks, you would have failed there too. XLF is up 16.4% and even JPM, with the whale trade and LIBOR is still up 11.5% this year (remember how bearish everyone was on banks at the start of the year?).

Okay, what about Europe? Well an investment in the STOX 50 would be down 1% in USD, but still up 4.9% in Euro. The Nikkei is up 7.5% in Yen terms and 4% in dollars.

China, with all of its problems and daily headlines of various types of landings, is down only 4% in local terms and 5% in USD.

In many ways it would have been hard to lose money investing in equities. Just simple equity investments and that’s without timing any of the bigger moves. Yet the composite hedge fund ytd return is only about 3%.

Fixed Income

The fixed income case is even more depressing for hedge funds. It has been almost impossible to find a losing investment here. The 10 year treasury return is over 2.5%, Investment Grade bond index is 7.9%, High Yield bond index is 8.6% and even boring, senior secured, floating rate leveraged loans have generated 7.1%. The Municipal bond index is up only 5% but some of that income is tax-free. Emerging markets have been stellar with core dollar denominated debt up 11.9% and even local currency debt now up 4.4%.

Even an investment in a 5 year Italian bond would be up 8.8% so far. I haven’t converted that to dollars where it is less, but this number is worth thinking about. Close your eyes, but Italian 5 year bonds at the start of the year, and you would be up 8.8% so far in Euros. At least Spain has had the decency to be down. Had you bought 5 year Spanish bonds at the start of the year you would have a 2.1% loss in Euros (slightly less in dollars). All the time and focus spent on how bad Spain is and you would only be down 2.1% on a five year bond, strikes me as surprising.

On fixed income, I continue to believe that specific credit and bond selection is necessary here, as the “go go” bonds have gone about all they can. The ETF’s are underperforming the benchmarks in many cases now, at least in part because the “beta” has been played out.

Others

The dollar has done well this year. Investing in DXY would have produced a 3.2% return. Investing in commodities would have lost 3.3% based on the CRB index. That surprised me, given how much talk there is about inflation.

Can You Sell Sharpe Ratio?

At a glance, the hedge fund composite index returns are pretty lackluster. Obviously some funds have done a great job, some are designed for low volatility or tail risk environments, etc., but some are designed to generate total returns for their investors. It must be getting hard for some investors to wonder why they are paying 2 and 20 to get returns that just aren’t that good. So many investments have outperformed, and there are so few losers, some investors will question how it was possible to achieve such low returns.

That is the key game that is getting played out now. The weaker hedge funds, those without long track records and good relationships with their investors are racking their brain on how to outperform coming into year end. Clients may say they want steady returns, especially in bad times, but we all know that many of them are as likely to chase returns as stick with that philosophy.

These weak funds need returns, not sharpe ratio. They need to keep assets under management. They need to justify their existence. It is reasonably safe to assume that many of the laggards have been short the market, since so much has gone up. They can add to that position, or they can decide not to fight the Fed and ECB and go long chasing returns that way. I think every day now that we continue in this low volume, low volatility environment, these funds will become more and more tempted to chase returns from the long end and will scrounge the world for the highest beta assets that they can buy and push up in this low liquidity environment.

Clearly the good funds remain in the driver seat, but they have the luxury of being patient and figuring out what they want to do. It is those most desperate for returns into year-end that are likely to swing for the fences, and I think it is becoming more likely that means another big push higher in risk assets.

I wouldn’t do it if I was them. I remain between 0% and 50% now and continue to be tempted to set shorts (I’m now eyeing the S&P Sept 1,370 puts since they are cheaper than when I started watching the 1,350’s). For now I remain long and biased towards Spain, Italy, banks, and continue to think CDS can have a capitulation tighter (low trading volumes will turn the big banks into net income hogs again, reducing their desire to hedge).