Hedge fund returns should not be compared directly to equity benchmarks. Hedge fund marketers will always say this, and with some reason: hedge fund strategies have a different risk-return profile from equities. Many allocate a lot of money to “short” positions, betting against the market. So it is not necessarily that surprising or damning when equity hedge funds suffer a very bad year compared to the index, as happened last year. That was a big part of my discussion with Hedge Fund Research’s Ken Heinz in the latest Note video:
But it is interesting to look at how hedge fund investors seem to have behaved. And in aggregate, they look a lot like classic retail mutual fund investors, chasing performance and piling in after a good run. Inflows to hedge funds last year were slightly lower than they were in 1993, according to HFR (and obviously far smaller in percentage terms). The great boost to hedge funds’ assets came in the years after the dotcom crash of 2000, when many funds managed to rise.
In his first term, US president Barack Obama oversaw the second-biggest rise in the stock market of any US president since the second world war. James Mackintosh, investment editor, says his second term hopes of economic recovery rest more on the housing market than equities.
My post on the inherent bias towards bullishness among Wall Street’s analyst community prompted an interesting response from Ian Harnett at Absolute Strategy Research.
He agrees in principle that sell-side analysts and strategists tend to be pro-cyclical, raising predictions as the market rises (his London research house is on the sell-side too, it’s worth noting).
But he argues that when analysts refuse to raise their forecasts in line with rising markets, that is a good sign for investors – and that this is exactly what’s happening now. When it happened in 2005-6, the market soared even as analysts became more cautious.
Source: Absolute Strategy Research
It has long been known that Wall Street analysts working for investment banks (the sell side) are biased towards shares going up, from which they and their employers benefit.
This chart from Kevin Gardiner, head of European investment strategy at Barclays Wealth (part of the bank on the buy side, not the sell side) shows analysts tend to start each year optimistic, then become less optimistic as the year goes on. Each line shows how S&P 500 profit forecasts for a single year developed as time went by. Only in 1988, 2005 and 2006 did they end up more positive than they started, yet hope continually overcame reality.
Source: Barclays Wealth
There’s an intriguing explanation for the bias of sell-side strategists from Dhaval Joshi at BCA Research. The way for a strategist to prosper is to be right as frequently as possible – and he should know: he is a sell-side strategist himself. Assuming that the strategist can’t forecast the market with any accuracy, that means it is best to ignore the odd period of big losses and instead focus on the higher likelihood of rises.
It is quite reasonable to assume forecasts will not be accurate, partly because of their history (chart below) but mostly because if a strategist could accurately forecast the market, they would not need to work for a living.
Calm in the eurozone has come at a cost to the havens. James Mackintosh, investment editor, points to the sliding Swiss franc and sterling, and warns the premier haven of choice, London property, could be next.
Small caps in the US have hit their fifth new high of the year and UK smaller companies soared past their previous peak a month ago – both climbing 172 per cent since 2009. But James Mackintosh, investment editor, warns that if the current rally peters out small caps look particularly exposed.
The yen’s collapse was rudely interrupted on Tuesday. James Mackintosh, investment editor, points out that the yen’s premium as a haven from the global crisis has now evaporated, and examines the implications for the carry trade.
Goldman Sachs’ strategists are currently roaming Europe on their annual Global Strategy roadshow. As nobody can lightly ignore what Goldman is saying, the themes emerging from the London event were interesting.
Of particular concern are the prospects for corporate earnings; Japan; and the hope that 2013 will at last be the year for a “great rotation” out of bonds and into stocks.
On earnings, David Kostin, their US equity strategist, explains their view in the video below. In a nutshell, margins are high, but without a recession (which nobody expects) there is no need for a sharp reversion to the mean. Instead, forces such as shale gas will help profitability, but there will be little increase in margins as in many sectors they are already at historical highs. So margins stay at their plateau, and earnings rise gently thanks to the gentle recovery of the economy.
On Japan, bullishness is what might almost be called a “consensus contrarian” call. Many people are talking bullishly about Japan, despite its decades of under-performance. So many, indeed, that it is hard to call this call contrarian any more.
If you go down to the woods today, you won’t need a disguise: the bears are all at their annual picnic (OK, conference) in west London, led by uber-bear Albert Edwards of Société Générale.
He’s picked a good day to warn of looming disaster: yet another indicator suggests investor complacency is approaching danger levels thanks to the new year rally.
Short-term momentum indicators were flashing red in Europe last week, and even after falling back slightly remain very high.
More than half European companies have dividend yields above corporate bond yields for the first time, while mutual fund sales saw their biggest weekly inflow into equities since the US stock market peaked in 2007. James Mackintosh, investment editor, analyses whether this is the long-awaited rotation from bonds back into stocks – and how to compare them.