Paper Boat in Stormy Sea

Market Volatility Hits Active Managers Hard

Paper Boat in Stormy Sea

It didn't take long for investors in James Cordier's hedge fund to find out their money had been wiped out by a series of nasty market whipsaws.

Just days after intraday natural gas prices surged, Bloomberg News reported the veteran options trader used a YouTube video to relay the bad news in late 2018 to his high-net worth investors. (See Cordier's taped condolences to his clients below.) 

Describing a sudden upturn in oil and gas volatility as a "rogue wave," Cordier conceded that big twists and turns in commodities "likely cost me my hedge fund."

Such a grief-stricken concession probably came as little solace for those who'd put their life savings into his trading strategies. According to Bloomberg, at least $150 million in assets were estimated to have been lost after the hedge fund was forced to liquidate.

Unfortunately, these investors weren't the only recent examples of those who've seen their savings lost by an active manager's failure to correctly time short-term bouts of market volatility. Despite such a public example of the failings of a rather opaque hedge funds marketplace, active managers who ply their trade by using hedging strategies aren't immune to difficult times. 

When markets tumbled in early March 2020, one of the most popular types of hedge funds -- so-called risk parity funds -- surprised many investors by falling more sharply than "long-only" blue chip stock rivals, according to the Financial Times.In fact, the most widely followed S&P 500 risk parity index fell in the initial week by its most in almost 12 years, the report noted.

These types of investment vehicles are sold based on their active managers' ability to control volatility across a wide variety of different asset classes and global markets. That's why they're known as "risk parity" hedgies, touting an ability to trade in a way that keeps their underlying holdings tame even in periods of heightened market volatility. 

The risk parity party ended with a big thud, however, as the coronavirus pandemic ripped through the hedge funds industry. As reported by the FT, the biggest losers in this group included risk parity funds offered by Wealthfront, AQR and Putnam. One hedgie characterized to the paper losses wracked up during this volatile period as exposing a "painful structure" and a "cocktail" that was proving to be "very bad" for investors.   

In early 2020, data compiled by independent market researcher eVestment showed that hedge fund investors withdrew a net $98 billion in calendar year 2019. At the same time, CNBC reported that by some counts total assets held in hedge funds during that 12-month timeframe settled at $3.3 trillion as these types of managers on the whole generated an average return of 10.4% -- their best performance in more than a decade.2 (By comparison, the IFA SP 500 index gained 31.44% while the IFA World Index returned 21.14% in 2019. Both are long-only equity benchmarks.) 

As chronicled in the Wall Street Journal's special report ("Twighlight of the Stock Pickers: Hedge Fund Kings Face a Reckoning") in late 2019, hedge-fund managers once reigned over the investment industry. As a group, however, these active managers have been bleeding assets for more than three years. The article sites statistics from researcher at HFR Inc. showing through last year, the hedge funds category had undergone a historic stretch of net ouflows. "The reason isn't hard to find: They're no longer especially good at picking stocks," the WSJ piece summarized.3  

Indeed, the paper highlights some pretty eye popping numbers. In 1990, just 530 hedge funds were being sold. By the end of 2019, more than 8,000 were being offered to high net worth investors. Starting in 2015, though, such a trend started to reverse. "There's been a parade of hedge-fund shutdowns ... In each year since 2015, more hedge funds have closed down than have launched, according to HFR," the report notes. 

If you'd prefer to avoid receiving a message like the one sent out by Cordier, we urge you to plan ahead for your family's financial well-being. As we've repeatedly written in the past, investors with a long-term plan already in-place can patiently let market ebbs and flows work to their advantage over time.

Of course, a critical part of making sure a disciplined financial plan can work properly involves weeding through thousands of different investment choices to select funds with strong track records and well-designed indexes. (To find out more about how we approach such an asset allocation process, see our article: "Selecting Investments Part 1" on IFA.com.) 

Backed by a rigorous research process, a wealth of academic evidence gives IFA's investment committee confidence that sticking to a strategically minded financial plan -- grounded in a globally diverse and passively managed investment portfolio -- provides our clients with their best opportunities to realize higher returns over time, net of fees.

The alternatives just don't paint a very pretty picture.

In the painting above, titled, Whom Should You Trust?, the dilemma of investors is depicted. On one side is the slick salesman of Wall Street products and services. Tugging on the other side is an academic who provides unbiased research that does not require the facade of a polished advertising campaign. The investors are caught in the middle, torn between the forces of salesmanship and empirical evidence. Hopefully, they will listen to the evidence.


Footnotes:

1.) The Financial Times, "Risk Parity Funds Suffer Worst Week Since 2008," March 13, 2020.

2.) CNBC, "Investors Pulled Nearly $100 Billion from Hedge Funds in 2019," Jan. 27, 2020. 

3.) The Wall Street Journal, "Twighlight of the Stock Pickers: Hedge Fund Kings Face a Reckoning," Oct. 27, 2019.


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