Yesterday’s plunge in AAPL, which as we noted is one of the most widely held names by the hedge fund community with some 163 names long the stock, cemented what has already been a terrible start to 2016 for most hedge funds following a comparable blow up in Allergan one month ago, arguably the most popular at the time stock within the hedge fund community.
Overnight, none other than Third Point’s Dan Loeb confirmed as much when he said that hedge funds are in the first stage of a “washout” after “catastrophic” performance this year, to wit:
The result of all of this was one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund…There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies.
Loeb adds that the “increasing complexity” – or perhaps simplicity, recall that all one has to do to make money is to successfully frontrun central bankers – in markets over the past few months is here to stay, Bloomberg adds. Most investors were “caught offsides at some or multiple points” since August, Third Point said, when China’s surprise currency devaluation roiled global markets.
The firm said market participants were hurt by bets against the yuan in February and investments in Facebook Inc., Amazon.com Inc., Valeant Pharmaceuticals International Inc. and Pfizer Inc.
“Further exacerbating the carnage was a huge asset rotation into market neutral strategies in late the fourth quarter,” Third Point said. “Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field.”
But perhaps the latest, and most amusing fact about Dan Loeb, is what he has changed his BBG MSG header to.
Some more excerpts from his Q1 investor letter:
Review and Outlook
Volatility across asset classes and a reversal of certain trends that started last summer caught many investors flat-footed in Q1 2016. The market’s sell-off began with the Chinese government’s decision to devalue the Renminbi on August 11, 2015 and ended with the RMB’s bottom on February 15, 2016, as shown in the chart below:
By early this year, the consensus view that China was on the brink and investors should “brace for impact” was set in stone. In February, many market participants believed China faced a “Trilemma” which left the government with no choice but to devalue the currency if it wished to maintain economic growth and take necessary writedowns on some $25 trillion of SOE (State Owned Enterprise) debt. Based largely on this view, investors (including Third Point) crowded into short trades in the RMB, materials, and companies that were economically sensitive or exposed to Chinese growth.
Making matters worse, many hedge funds remained long “FANG” stocks (Facebook, Amazon, Netflix, and Google), which had been some of 2015’s best performing securities. Further exacerbating the carnage was a huge asset rotation into market neutral strategies in late Q4. Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field. Finally, the Valeant debacle in mid-March decimated some hedge fund portfolios and the termination of the Pfizer-Allergan deal in early April dealt a further blow to many other investors. The result of all of this was one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund.
When markets bottom, they don’t ring a bell but they sometimes blow a dog whistle. In mid-February, we started to believe that the Chinese government was unwilling to devalue the RMB and was instead signaling that additional fiscal stimulus was on deck (an option that the bears had ruled out). Nearly simultaneously, the dollar peaked and our analysis also led us to believe that oil had reached a bottom. We preserved capital by quickly moving to cover our trades that were linked to Chinese weakness/USD dominance in areas like commodities, cyclicals, and industrials. We flipped our corporate credit book from net short to net long by covering shorts and aggressively adding to our energy credit positions. However, we failed to get long fast enough in cyclical equities and, while we avoided losses from shorts, we largely missed the rally on the upside. Unfortunately, our concentration in long health care equities and weakness in the structured credit portfolio caused our modest losses in Q1.
So where do we go from here? As most investors have been caught offsides at some or multiple points over the past eight months, the impulse to do little is understandable. We are of a contrary view that volatility is bringing excellent opportunities, some of which we discuss below. We believe that the past few months of increasing complexity are here to stay and now is a more important time than ever to employ active portfolio management to take advantage of this volatility. There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies. We believe we are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets.
Full letter below:
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