It’s been a rough several months for hedge fund investors.
And Third Point’s Dan Loeb thinks this period has been the toughest since Third Point opened up shop in December 1996.
At the top of his latest letter to investors released on Tuesday, Loeb walks through the main challenges that have been seen in markets and the crowded hedge fund-centric trades that seem to have all gone the other way.
The Chinese yuan didn’t collapse, major momentum stocks like Amazon and Netflix declined, Valeant continued to crater, and the year’s biggest pharmaceutical deal was called off.
But for Loeb, the story starts and ends with China, beginning on August 11, 2015 with the surprise devaluation of the yuan and ending with the yuan’s bottom on February 15.
Third Point, like many hedge funds, was betting on a further devaluation of the yuan. And while that may well come, a number of other popular trades were pressuring the asset class while efforts to “de-risk” portfolios didn’t accomplish what some perhaps hoped.
Here’s Loeb (emphasis mine):
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.
Through March 31, Loeb’s Third Point fund is down 2.3% against the S&P 500’s 1.3% gain.
Since inception the fund is up 15.8% annualized against the S&P 500’s 7.3% gain.
But for Loeb, what we’ve seen is not the end of some treacherous period for the industry but the beginning of what he thinks will be a “washout” in hedge funds and other strategies. And in this, Loeb echoes his view from February’s investor letter in which he described the market situation as a “Wall Street recession.”
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.