The end of an era for hedge funds

Is this another flashing warning sign?

This week, a $7bn hedge fund shut down. Eton Park, run by Goldman Sachs child prodigy Eric Mindich (at the tender age of 27, he became the youngest partner in Goldman history), launched in 2004, with $3.5bn under management, one of the largest such launched ever at the time.

But it’s had a rough time, particularly since 2009. The fund lost 9% last year in a year in which the US S&P 500 returned nearly 12% (including dividends). That’s a really awful underperformance. So far this year, according to the Wall Street Journal, the fund is flat, versus a gain of around 5% for the S&P.

It’s a big name, but hardly the only casualty. More than 1,000 funds shut down last year – the most since the 2008 financial crisis – and there are now fewer funds around than at any time since 2013. A grand total of 8,326, according to data group HFR.

What’s going on?

I can’t help but think that it’s interesting that hedge funds – in many ways, sold as the ultimate in “active” investing, and certainly among the most expensive ways to invest out there – are in decline just as passive investing in ultra–cheap funds is really taking off in a serious way.

Hedge funds have presented themselves as being victims of easy monetary policy and central bank money printing. In effect, trades based on what “should” happen have been disrupted and reversed by the intervention from on high by the likes of Janet Yellen and chums.

Meanwhile, others argue that passive funds have benefited greatly from this environment. In effect, the “dumb” money has done well while the “smart” money has struggled. “Beta” has been given an easier ride than “alpha”.

I think this is rather a self-serving way to look at things (surprise, surprise). If your investment strategy is based on “big picture” events (“macro”, in the jargon) and timing the market, and yet it doesn’t attempt to take the actions of central banks and politicians into account, you shouldn’t be in the “macro” business.

All the same, the closing down of this particular fund and the accelerating popularity of passive exchange-traded funds is another sign of the sort of “fin de siècle”-type shifts you often see near a top. You could also argue that it’s populism that has blindsided the hedge funds (as it has the markets). Could this be a sign that we’re hitting a peak of some sort?

As I said earlier in the week, the tricky thing about turning points is that you don’t get any alarm bells going off that tell you exactly when to sell. But it’s clear that conditions are ripe for a shift.

Keep an eye on the US jobs market

Here’s another interesting data point on that front: Dave Rosenberg of Gluskin Sheff sent over an interesting note comparing the US stock market to initial jobless claims data.

The initial jobless claims data measures how many people are claiming out of work benefits in the US. It comes out weekly. It’s been going down for most of the time since 2009, and is now hovering around its lowest levels for years.

One thing about jobless claims, says Rosenberg, is that it’s worth keeping an eye out for turning points. And last week, claims jumped quite significantly – rising by 15,000 to 258,000. Also, the four-week moving average looks as though it “hit its cyclical trough on February 25th.”

If that’s correct, then it could be a big deal. You see, “lows in jobless claims are a classic late-cycle development. Just as when claims are hitting their peaks and everyone laments that the bad times are never going to end, well, those actually are the times when you want to start dipping more toes into the equity pool.”

To be precise, the S&P 500, on average “peaks 14 weeks after the bottom in the four-week moving average in claims”. And then, after 57 weeks, a recession starts.

Hmm. If we’re looking at 14 weeks from 25 February 25, that’s around about the end of May, early June for the market to peak. “Sell in May”, right enough.

I think I’ll add this to our list of “key charts” to watch.

This high street giant is worth looking at 

I don’t often look at individual stocks, but I have to say that fashion chain Next (LSE: NXT) did catch my eye this week. The high street giant has taken a pounding over the last year or so – at the end of 2015 it was trading at around £80 a share, and now it’s almost half of that level.

Until recently, it’s looked like a falling knife – a stock more liable to cut your fingers off than rebound in a rewarding manner. But the results this week were encouraging. Not because they were good, but because it sounded like the chief executive Simon Wolfson has got a handle on what’s gone wrong.

He also made a proper attempt to discuss the issue of ‘bricks and mortar’ retailing and its decline – stress testing the property portfolio to figure out how much of a liability its store estate could turn out to be. The good news on that front is that the company’s “lease structure is such that the portfolio could be managed down profitable”.

The share price rebounded by 9% on the day. I reckon it’s hit a turning point now. I haven’t bought in myself yet but I am tempted to. I’d suggest that if you’ve had your eye on it, now’s the time to be investigating further.

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