Crisis-hunting hedge funds enjoyed blowout returns in March, but investors say the strategy of waiting years for markets to crumple is still unlikely to draw new fans.
Funds that seek to profit from collapses have gained 57.2 per cent so far in 2020 — their best year on record — reflecting the damage inflicted by the coronavirus pandemic.
Standouts include New York-based Capstone’s “tail risk” strategy, up 350 per cent over the first three months, and 36 South Capital Advisors of London, whose $2bn flagship fund is up more than 130 per cent. Theirs are among the best-performing strategies in the world this year, even as most hedge funds and other investors are nursing losses.
Another big winner is Mark Spitznagel’s Universa Investments, which boasts that its tail risk strategy — designed to profit from highly unusual swings in asset prices — has made a return for investors of more than 4,000 per cent this year.
But Mr Spitznagel, who, in addition to his fund, runs a cheese farm in Michigan, is still not expecting a large inflow of new investments. Universa’s strategy should be a part of many investors’ portfolios, he said, as a way of protecting against violent moves. “But we never will be, because most people only want it when there’s a crash.”
Tail risk funds captured investors’ imagination during the 2008 crisis, generating large profits as markets tumbled. Their popularity was helped by the best-selling 2007 book The Black Swan, by former hedge fund manager Nassim Nicholas Taleb, who now advises Universa. One of Mr Taleb’s key arguments was that unexpected events that can shake our view of the world are more common than we think.
Such an event happened in March, when efforts by governments around the world to control the coronavirus pandemic sparked a record-breaking rush out of risky investments.
“The virus is popping the bubble,” said Mr Spitznagel. “Markets were priced for perfection, but all of a sudden the world lost its veil of perfection.”
Even with the huge gains so far this year, many funds in the sector remain deeply in the red after a long bull market punctuated by occasional dips.
“This strategy costs you most of the time,” said Cedric Vuignier, head of alternative investments at SYZ Asset Management, who said he has not invested in such funds for several years.
“Moreover, it is really difficult to time the entry and sometimes you don’t have the time to get out,” he added, citing the Brexit referendum in 2016 and the market sell-off in February 2018, when big gains were rapidly unwound.
Such funds on average lost money every year from 2012 to 2019 inclusive, according to CBOE Eurekahedge’s index of tail risk hedge funds. Despite having three crises to profit from since the start of 2008 — the global financial crisis, the eurozone debt crisis and the coronavirus crisis — they are still down by an average of 24 per cent over that period.
Protection strategies should be assessed “over the full market cycle from boom to bust, including long stretches of low volatility and stock market gains”, said Ari Bergmann, chief investment officer of Penso Advisors, a specialist in derivatives protection that is 25 per cent owned by hedge fund firm Brevan Howard.
The 131 per cent gain made by 36 South in its flagship Kohinoor fund puts it on track for easily its biggest annual gain since launch in 2011, according to an investor letter seen by the Financial Times.
The fund profited mainly from bets on equity options, as well as currency and commodity options. Chief executive Jerry Haworth wrote in March that “we are all on the bus and that bus is now on the highway to stagflation hell”.
However, Kohinoor lost money for five straight calendar years before 2020. A sum of €1,000 invested at the fund’s launch would now be worth €685, even taking into account this year’s gains. 36 South declined to comment.
Man Group’s TailProtect fund also lost money for five consecutive years to 2020. But, just as it was starting to make money from the coronavirus crisis, it was shut down as investors pulled out their cash.
A small number of hedge funds in other sectors have had some success exploiting volatility, but without suffering quite so many losses in between.
Dominicé & Co’s volatility-trading Cassiopeia fund, for example, gained nearly 21 per cent in March, yet has also made money in 14 of the past 16 years. One River Asset Management’s Dynamic Convexity fund, another volatility specialist, is up 53 per cent this year and also up since launch in 2015.
But for outright Black Swan funds, the uncertainty as to when the next big payout will come means they are unlikely to regain the popularity they enjoyed in the aftermath of the 2008 crisis.