Hedge funds clobbered by tech

A particularly volatile streak in the technology sector and setbacks in other growth stocks are creating the least hospitable market conditions for equity-focused hedge funds in at least a year and a half, say market participants, creating sizable losses in a matter of days.

Since the beginning of April, large hedge funds such as Viking Global Investors, Maverick Capital and Lone Pine Capital have stumbled likely in part due to losses on their tech positions, people familiar with the matter said. Overall, the average stock-focused fund fell 1.23 percent in the first week of April, according to report from Bank of America Merrill Lynch.

"The past two weeks for hedge funds have been diabolical," said one stock-fund manager who has been struck by the sharp intraday swings in both the Nasdaq Composite Index and the iShares Russell 2000 small-stock index, which have fallen by a respective 2.6 percent and 3.2 percent in April so far. Monday, April 7, on which the Nasdaq's gyrations were especially pointed, he added, "was one of the worst days for hedge funds since 2008."

A second trader at a different equity-trading fund said colleagues had been joking that it would take them all year to make back the money they've lost so far this month—that is, if they are able to at all. Still, this trader added, people aren't yet giving up hope that the broader equities-market rally will continue.

In recent weeks, tech stocks have taken a drubbing, with high flying names like Twitter, Yahoo!, and Netflix, which are part of the Nasdaq index and had been in vogue in the professional money-management community, hit especially hard. But other growth-stock sectors, including biotech and consumer discretionary stocks, have also declined, contributing to a downswing in the Russell, which is a popular vehicle for hedge funds that are betting on stock-market growth.

Viking, which manages $28 billion, is down nearly 4 percent through April 11 in its flagship fund, according to someone familiar with the returns.

One of its largest positions as of a Dec. 31 regulatory filing was Facebook, which fell nearly 3 percent over the period (it has since rebounded slightly). Maverick, which manages about $9 billion in assets, lost 3 percent in its flagship in the first few days of April, another person familiar with its returns said. The fund's largest position as of Dec. 31 was eBay,which fell more than 4 percent in the first week of April.

Lone Pine, the $27 billion fund, has also faltered this month, said yet another person familiar with its returns. The fund's largest long position is Cognizant Technology Solutions, according to a recent report in Absolute Return, and it also has fallen.

Other tech-heavy hedge fund losers in April include JAT Capital (down 4.4 percent through April 11) and Cadian Capital (down 1.8 percent through April 15), according to a person familiar with the returns. Both firms manage between $2 billion and $3 billion.
Read MoreHow tech blowups at hedge funds can hurt you
The pain at many of the same funds was already apparent in the first quarter, when a slew of prominent hedge funds took losses--mostly as the market turned south in March. Viking, Lone Pine, Blue Ridge, Jericho Capital Partners and JAT all sustained losses (all ended March at a loss with the exception of Viking, which finished up 0.6 percent).

Amid the tumult, Coatue Management, the approximately $9 billion fund company that lost 9 percent in its flagship during the month after betting wrong on both long and short stock holdings, revealed plans to return $2 billion to investors at midyear.

The global multi-asset portfolio (paper)

The global multi-asset market portfolio contains important information for strategic asset-allocation purposes. First, it shows the relative value of all asset classes according to the global financial investment community, which one could interpret as a natural benchmark for financial investors. Second, this portfolio may also serve as the starting point for investors who use a framework in the spirit of Black and Litterman (1992), or for investors who follow adaptive asset-allocation policies as advocated by Sharpe (2010). We estimate the invested global market portfolio for the period 1990-2012 by estimating the market capitalization for the eight asset classes: equities, private equity, real estate, high-yield bonds, emerging-market debt, investment-grade credits, government bonds and inflation-linked bonds. For the main asset categories - equities, real estate, non-government bonds and government bonds - we extend the period to 1959-2012. We provide these annual historical estimates in tabular form so that practitioners and academics can easily use these historical data going forward. To our knowledge, we are the first to document the global multi-asset market portfolio at these levels of detail for such a long period of time.

from Jan 2014 Update of “The Global Multi-Asset Market Portfolio 1959-2012″

Rob Arnott video: A better mousetrap?

http://wealthtrack.com/recent-programs/robert-arnott/

A Spectrum of Possibilities (Probabilities)

Valuation works over long time periods.  In the short term, anything can happen.  The US market was slightly expensive at the end of 2012, but lo and behold it returned over 30%.  Below is a fun chart of yearly CAPE values back to 1900 and future 1o year returns, and I will keep the commentary light as the conclusions should be fairly self evident.  Notice most of the red and yellow years end up on the left side of the chart of low returns, although there are some on the right side.  And vice versa with the green ones.

Most investors like to think in binary terms.  Stocks are either cheap and a buy, or expensive and a sell (or crash!!!).  I’m convinced they think this way along the same lines they like to cheer for sports teams (it’s more fun).  I tell investors using valuation is a spectrum of future possibilities.  While buying expensive markets generally will produce lower future returns, you will have positive outliers.  The same for cheap markets, it’s usually a good idea but they can always get cheaper.  

THE “STOCK PICKER’S MARKET” FALLACY

One of the most misused and destructive phrases in the investment world is the notion of a “stock picker’s market.” Depending on the market environment, it is used in different ways, but all generally incorrect.

In a relentless uptrending market, investors become highly confident in their ability to pick stocks, naturally calling it a “stock picker’s market.” After all, any stock they pick is going “up and to the right.” We saw the most extreme example of this in 2013, which set a record in terms of breadth with 93% of stocks in the S&P 500 finishing positive on the year. Never mind the fact that a blindfolded monkey throwing darts was likely to pick a winning stock last year; most investors came out of 2013 believing they were the next Warren Buffett.

In a sideways or down market as we are observing this year (52% of stocks in the S&P 500 are positive as of 4/11), the financial media throws out the term “stock picker’s market” to keep investors interested in the game. You just need to “do your homework,” they say, and separate the wheat from the chaff. After all, “there’s always a bull market somewhere.” While there is some truth to this phrase, the question is whether most investors can find that “bull market” with any consistency. Regrettably, all studies I have seen on this subject show that they cannot. On average, investors are notoriously poor traders and stock pickers and would fare much better spending their time on more boring concepts such as risk tolerance, asset allocation and rebalancing.

One of the primary reasons why investors are poor stock pickers has to do with behavioral finance. Armed with no methodology, investors naturally rely on their emotions to make decisions. For these investors, “doing their homework” means simply finding the stocks that have done the best in the most recent past (recency bias), are most popular (herding), or are recommended/owned by gurus and wall street analysts. Unfortunately, these are all terrible reasons for buying a stock.

At the end of last year, if you knew nothing about investing and wanted to pick a stock, you would have likely gone with one of the best performers in 2013. How would this strategy have performed? The Top 25 performers in 2013 are down an average of -2.1% this year, undperforming the S&P 500 (SPY). The two best stocks in 2013, Netflix (NFLX) and Best Buy (BBY), are both showing double digit losses.

Alternatively, you may have chosen a stock because some prominent hedge fund was in the name, uncovering this information from lagged 13F filings. This methodology would have performed even worse as measured by the Global X Top Guru ETF (GURU) which pursues such a strategy. GURU is down -8% YTD, substantially underperforming the market.

On the other hand, how many investors would have selected a stock from the bottom 25 performers of 2013, all of which were down last year and hated by Wall Street analysts? My guess is not many but if they had, they would have fared much better, with an average return of 6% thus far in 2014. The worst two stocks in the S&P 500 in 2013, Edwards Lifesciences (EW) and Newmont Mining (NEM), are both positive this year. A simple strategy that would have went long the bottom 25 performers and short the top 25 performance of at the end of 2013 would have been up over 8% this year.

Overall, most investors would do well to ignore the allure of “stock picking” and any notion that they have an innate ability to pick winning stocks. I know this may be hard to accept but it should be somewhat easier when you look at the performance of most institutional stock pickers who suffer from the same behavioral foibles. This is not to say that it is impossible pick winning stocks as there are certainly great stock pickers in existence. However, the casual investor with no process or strategy is highly unlikely to be among them. It is never a “stock picker’s market” for these investors.

Fortunately, though, stock picking is not a prerequisite to successful investing. In fact, it is the antithesis of successful investing for many. For most investors, instead of “doing their homework” in trying to find the next Google or Apple, they should be developing an appropriate asset allocation plan and sticking to it. While not as exciting as jumping aboard the latest 3D printing or biotech breakout, it is likely to be significantly more profitable in the long run.

The value of enduring advice

Five years have come and gone since the market hit bottom during the financial crisis. Nearly every investor who went through that period came away with a few important lessons. For many, the lessons are shaded with regret. Others are still searching for the right lesson; lessons buried under alternate histories of what could have been. For those who had a prudent voice guiding them to stay the course, the lessons are likely more enduring.

When we came up with the Vanguard Advisor’s Alpha™ concept more than a decade ago, we had these time-tested principles in mind: diversification, balance, and discipline. Back then, the conventional wisdom associated good financial advice with the ability to deliver market outperformance. Recognizing that wealth management is more complex and greater value could be generated by refocusing financial planning on long-term rather than year-to-year results, we steered the conversation of financial advice to enduring principles.

Using a client-relationship-focused model, Vanguard Advisor’s Alpha equips the industry with the tools to evolve the financial planning practice and, as a result, helps to redefine the value proposition of advisors.

Many advisors already practice these principles. Still, we felt that more could be done to demonstrate the value of this guidance so both clients and advisors could fully realize the benefit of embracing the Vanguard Advisor’s Alpha model.

Making the value of advice more concrete

Naturally, the next step was to put a number on the value of that advice—a value that, while real, is much easier to describe than define. After all, what was the value of keeping a client on course during the financial crisis? Such value is easier pegged by words than numbers.

In our quest, we did extensive research to quantify how much could potentially be added to clients’ net returns by implementing the Vanguard Advisor’s Alpha framework.

We came up with “about 3%.” Simply put, advisors can add “about 3%” in net returns when comparing the projected results of a portfolio that is managed using well-known and accepted best practices for wealth management with those of portfolios that are not.

The math behind the “3%” was the simple part and can be found in the recently published white paper, Putting a value on your value: Quantifying Vanguard Advisor’s Alpha.

The real work was framing the wealth management principles in a manner that would help advisors describe the value of their services to clients as clearly as possible. By showing how the Vanguard Advisor’s Alpha framework can affect net returns, we make the value proposition of advisors more tangible.

Obviously, the value will vary according to each client’s circumstances and from year to year. Nonetheless, it’s a number that is very real and can help in client conversations to reinforce the importance of sticking to a plan and following sound financial advice.

For advisors, being able to successfully communicate your value can free up time to focus on the pursuits that will make a bigger difference, such as strengthening client relationships and helping clients achieve their goals. In turn, your practice can benefit by having more satisfied clients and greater asset retention. From that standpoint, we believe the Vanguard Advisor’s Alpha framework is not only good for your clients but also good for your business.

Detailed information is included in our white paper, but here’s a summary of how the value of Vanguard Advisor’s Alpha breaks down:

For more information, please read Putting a value on your value: Quantifying Vanguard Advisor’s Alpha.

Rotation, rotation, rotation

It's been said that the three most important factors in property are location, location, location.  It's a bit of a hackneyed line, perhaps, but as anyone who has ever compared prices in New Cross and Blackheath (or Bridgeport and Darien) could tell you, it's not without a kernel of truth.  Similarly, to understand what's going on in equity markets recently, all you really need to know is rotation, rotation, rotation.

If broad equity index moves are the classical physics of finance, explaining the world on a large scale, then sector rotation can be considered the quantum mechanics, occasionally hiding a seething ocean of activity not always visible through a macroscope.

Such is the story recently.   Of course, to many macro punters, the word "rotation" brings to mind the theory of The Great Rotation out of bonds back into equities that was such a story in 2013 (and painful reversal in January 2014.)



Recently, however, there's been a different kind of rotation.   Erstwhile star performers, many of whom boast eye-watering valuations, have been trampled over the last few weeks while many popular shorts have screamed higher.   Nowhere is this more evident than in the case of biotech vs. emerging markets.  Perhaps we can call the last couple weeks' price action the "Hate Rotation"?



Indeed, the biotech/EM ratio has needed just six weeks to retrace a quarter of its entire move since 2010!



Unsurprisingly, more prosaic RV trades such as growth versus value have come under the cosh as well....



Unlike the IBB/EEM trade, however, the growth vs value pullback looks fairly orthodox and well within the scope of historical norms.   As such, it's probably premature to sounds the klaxons warning of a 2007-style Quantmageddon in equity land.

What's interesting to observe is that at least some of the buying in EM has been very real.  Anecdotes suggest real money managers are seeing inflows, and Macro Man himself pointed out the huge, rather institutional-looking inflow into EMB last week.  Should it continue, the Hate Rotation could keep chugging along.  As an aside, it's interesting to note that while EEM has seen an increase in shares outstanding, EWZ (the Brazilian ETF) has not, despite a 20% rally over the last 3 weeks.   As such, Macro Man will being keeping a weather eye on EWZ as an indicator of further pain.



Finally, earnings season kicks off this week, with companies no doubt ready with a plethora of weather related excuses for any shortfalls.  Macro Man has already circled the week of the 21st on his calendar and stocked up with popcorn, for in the span of a few days the top 5 largest holdings in the IBB biotech ETF all report.   

April 1st Mutual Observer Letter is Up: Recommended Read

http://www.mutualfundobserver.com/2014/04/april-1-2014/

BREAKING DOWN THE MOMENTUM BREAKDOWN

most investors who only follow the S&P 500 (SPY) would assume that it has been a relatively quiet month. The S&P 500 is currently flat in March and the high to low range in the index during the month is a very calm 2.7%. In fact, this is the lowest intra-month range in the S&P 500 since January 2007, and the lowest since the current Bull Market began in March 2009 (see table below).

Beneath this calm exterior, however, there is massive reversal going within the high momentum group. Momentum stocks, as illustrated by the Momentum Factor ETF (MTUM), had been strong outperformers on the year heading into March. From the start of the month, though, we have seen a complete reversal and more in this relative strength with momentum stocks now underperforming the S&P 500 (see top panel of chart below). We are also seeing sustained weakness in two of the strongest groups within the high momentum sphere: the Biotechs (XBI) and the Social Media (SOCL) names (see 2nd and 3rd panels of the chart below).

On an absolute basis, the decline has accelerated over the past two weeks. A number of top momentum names that were exploding higher from the start of the year through mid-March have declined between 10-20% over the past two weeks. The most prominent names in this group include Tesla (TSLA), Illumina (ILMN), Trip Advisor (TRIP), Facebook (FB), Regeneron (REGN), Netflix (NFLX), Biogen (BIIB), and Priceline (PCLN). All of these names are in either the Consumer Discretionary or Health Care sectors, with a concentration in Biotech and Internet groups (see table below).

Conversely, the momentum names that have outperformed since the middle of March tend to be more defensive in nature. Some well-known names in this group include Tyson Foods (TSN), Johnson & Johnson (JNJ), Hormel Foods (HRL), Berkshire Hathaway (BRK/B), and Kroger (KR).

This defensive behavior within the momentum universe is consistent with what we are observing in the broader market, with the Consumer Discretionary Sector (XLY) showing significant weakness relative to the Consumer Staples Sector (XLP) during the month of March. On a year-to-date basis, the more defensive Staples sector is outperforming the more cyclical Discretionary sector by over 4%.

Overall, it remains to be seen if this momentum reversal is merely a short-term pullback or is an early indication of a larger correction to come in the broader markets. At the very least, investors would be wise to look beyond the calm in the broad markets in March and pay closer attention to these names in the coming weeks. This is particularly true as it has been almost two years since the S&P 500 has suffered a 10% correction and momentum reversals have a history of occurring near market turning points.