Alternative Markets Update Q1 2020 And Macro May Outlook 2020

Hedge Funds
The hedge fund industry started with a record AuM of over $3.3tn to the year 2020. January and most of February looked promising, as the market continued its bull run of the last ten years with some minor exceptions during this time period. After covid-19 hitting Western countries, hedge funds have started to suffer. In sum, hedge funds have experienced the second worst quarter in history after Q3 2008. However, when looking at monthly returns, March 2020 exceeds the losses of any other month during the financial crisis when looking at average performance. Figure 2 shows the last 12 monthly returns and the previously worst month in the financial crisis, October 2008. As of 29th April, the AuM of hedge funds, which was higher than $3tn since 2014 dropped below this mark for the first time totalling $2.95bn. Despite the substantial inflows during January and February, the net flows within 2020 are negative now. Only relative value strategies and green funds have managed to generate net inflows this year. The performance of strategies in the hedge fund industry greatly varied, as crisis strategies, such as long volatility and tail risk are up 35% and 27% YTD, despite being the worst performing strategies in the last seven years. Equity hedge strategies, which have performed great during the last years, were hit hard, as equity long bias and long short bias are down 20% and 10% YTD. Debt funds were hit equally, as distressed debt is down 12% and fixed income is down 8% YTD. Most of the other strategies lie within a range of -10% to +5% YTD. Figure 3, and Table 1 respectively, show the returns of our indices compared to their benchmark indices.

As described previously, the majority of equity and debt strategies yielded negative results, so did our strategies with a few but notable exemptions. In equities, our market neutral US equities algo strategies is up 30.74% YTD. The remaining positive equity strategies are between +1 and +4% and focus on being long and short in US equities. However, as a whole, equity strategies are down 7.22% in March and 5.47% YTD, which compares well to the benchmarks shown in Figure 3. Our debt strategies were hit. Two out of seven strategies are slightly up in 2020, while two strategies returned substantial losses. Our debt strategies collectively performance approximately in line with benchmarks in 2020. Our tactical trading strategies performed very well in Q1 2020, as they are up 15% YTD collectively. This is exceptional, as only two of our six benchmarks are up, and those are only slightly up. The discretionary global macro strategy has realized a net return of above +50% YTD. The fund of hedge fund strategies performed around what an average hedge fund achieved in 2020 with a loss of around 8%. Our cross-asset indices, indices based on all of our strategies, are slightly down in 2020 with 2% and 3% in total.

Figure 2: Monthly Returns of the Last 12 Months and the Worst Month of the Financial Crisis in 2008, Source: Eurekahedge, April 2020

Figure 3: Performance of Stone Mountain Capital Indices Compared to its Benchmarks in Q1 2020, Source: Stone Mountain Capital Research, April 2020

Table 1: Performance of Stone Mountain Capital Indices Compared to its Benchmarks in Q1 2020, Source: Stone Mountain Capital Research, April 2020

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RESEARCH PERSPECTIVE VOL. 130 April 2020 Alternative Markets Update Q1 2020 The market demonstrated volatility since mid-February and the outbreak of the coronavirus in Western countries. Prior to the outbreak, the economy continued its bull run from the previous years, despite the knowledge of the coronavirus being around since December 2019. After the outbreak in Italy, it spread to almost every country and caused a wide variety of phenomena, which never occurred previously and outclass the financial crisis of 2008. Equity markets crashed and lost as much as never before in such a short time. Figure 1 shows the decline of the S&P 500 from about 3,300 down to approximately 2,250 within one month. While equity has already recovered, bonds and interest rate were impacted even harder. Despite the record stimulus packages by the Fed, the yield curve dropped to the lowest level ever including an inversion. However, this is not even the worst thing that has happened, as the whole US yield curve went below 1% during March. Aside from the frequent interest rate cuts by almost all national banks, oil was hit in parallel to the pandemic. Oil probably experienced the most unprecedented development among all assets. The oil price declined by 70% in one day alone, and this was not the bottom, as the price for a barrel crude oil dropped below $10. Furthermore, the May futures contract had a price tag of -$37 the day prior to its expiration, which obviously had never happened before as well and the USO ETF was impacted heavily by those rapid movements forcing a restructuring to longer dated contracts. With this background, we dive deeper in other asset classes such as hedge funds, cryptocurrencies, private equity and debt, as well as real estate in the following paragraphs. Figure 1: Development of the S&P 500 During the Coronavirus Crisis from 1st January 2020 until 29th April 2020, Source: Yahoo Finance, April 2020 Hedge Funds The hedge fund industry started with a record AuM of over $3.3tn to the year 2020. January and most of February looked promising, as the market continued its bull run of the last ten years with some minor exceptions during this time period. After covid-19 hitting Western countries, hedge funds have started to suffer. In sum, hedge funds have experienced the second worst quarter in history after Q3 2008. However, when looking at monthly returns, March 2020 exceeds the losses of any other month during the financial crisis when looking at average performance. Figure 2 shows the last 12 monthly returns and the previously worst month in the financial crisis, October 2008. As of 29th April, the AuM of hedge funds, which was higher than $3tn since 2014 dropped below this mark for the first time totalling $2.95bn. Despite the substantial inflows during January and February, the net flows within 2020 are negative now. Only relative value strategies and green funds have managed to generate net inflows this year. The performance of strategies in the hedge fund industry greatly varied, as crisis strategies, such as long volatility and tail risk are up 35% and 27% YTD, despite being the worst performing strategies in the last seven years. Equity hedge strategies, which have performed great during the last years, were hit hard, as equity long bias and long short bias are down 20% and 10% YTD. Debt funds were hit equally, as distressed debt is down 12% and fixed income is down 8% YTD. Most of the other strategies lie within a range of -10% to +5% YTD. Figure 3, and Table 1 respectively, show the returns of our indices compared to their benchmark indices. As described previously, the majority of equity and debt strategies yielded negative results, so did our strategies with a few but notable exemptions. In equities, our market neutral US equities algo strategies is up 30.74% YTD. The remaining positive equity strategies are between +1 and +4% and focus on being long and short in US equities. However, as a whole, equity strategies are down 7.22% in March and 5.47% YTD, which compares well to the benchmarks shown in Figure 3. Our debt strategies were hit. Two out of seven strategies are slightly up in 2020, while two strategies returned substantial losses. Our debt strategies collectively performance approximately in line with benchmarks in 2020. Our tactical trading strategies performed very well in Q1 2020, as they are up 15% YTD collectively. This is exceptional, as only two of our six benchmarks are up, and those are only slightly up. The discretionary global macro strategy has realized a net return of above +50% YTD. The fund of hedge fund strategies performed around what an average hedge fund achieved in 2020 with a loss of around 8%. Our cross-asset indices, indices based on all of our strategies, are slightly down in 2020 with 2% and 3% in total. Figure 2: Monthly Returns of the Last 12 Months and the Worst Month of the Financial Crisis in 2008, Source: Eurekahedge, April 2020 Figure 3: Performance of Stone Mountain Capital Indices Compared to its Benchmarks in Q1 2020, Source: Stone Mountain Capital Research, April 2020 Table 1: Performance of Stone Mountain Capital Indices Compared to its Benchmarks in Q1 2020, Source: Stone Mountain Capital Research, April 2020 Cryptocurrencies For cryptocurrencies, the outbreak of the coronavirus was especially interesting. In particular, as bitcoin (BTC) is oftentimes referred to as digital gold and as a safe haven asset. The crisis is an ideal opportunity to verify or dismiss this reputation. Prior to the outbreak, cryptocurrencies moved similar to the equity market and gained quite a bit. On the 20th February, as the first crash in equity markets occurred, caused by the spread of the virus in Italy, cryptocurrencies fell as well, but not to a similar extent as equities did. Noteworthy is, during this time, all assets, including gold, fell. The case for gold was different, as it was caused by a short-term lack of supply and according fear that there may be shortages in the future. The major crash in cryptocurrencies during the corona crisis is allegedly due to a hacking attack on a cryptocurrency exchange, whereas BTC fell to approximately 3,800$. Afterwards, it recovered quickly and remained mostly within a range of 5,500$ and 7,500$ until after the 20th April, after which it went up to more than 7,700$ occasionally. As per 29th April BTC traded at 8,900$. Ethereum (ETH) followed BTC developments more or less equally, aside from its bigger fall due to the hacking attack, as ETH was the targeted currency. The impact of the crisis is visible in Figure 4 for BTC and Figure 5 for ETH. The market capitalization obviously moved with the development of the price of the currency. The market capitalization of BTC is at 159bn$ and the market capitalization of ETH is at 24bn$ as of 29th April 2020. Figure 6 shows the development of the cryptocurrencies among each other. BTC is certainly meeting its expectation regarding its reputation of being a safe haven asset in the crypto space, as it lost the fewest value during the crisis by almost 10%, despite its significant loss of 39% until the 20th March, after which, alongside most other currencies, it rebounded strongly. Figure 4: Bitcoin Price Development from January 2019 to April 2020, Source: CoinMarketCap, April 2020 Figure 5: Ethereum Price Development from January 2019 to April 2020, Source: CoinMarketCap, April 2020 Figure 6: Relative Price Development of Several Cryptocurrencies During the Crisis, Source: Pantera Capital, April 2020 Private Equity The effect of coronavirus on private assets remains largely unquantifiable as of now, as reports for results of Q1 typically are not available until late May or June. There will be a substantial impact on the private industry including private equity but there are no definite numbers until these reports are released. As of now, the crisis has had barely an effect on the industry’s AUM, as visible in Figure 7. The AuM slightly decreased from its record in January 2019 with $972bn, although the cause was not the developments in 2020 but 2019. In January 2020, the AuM decreased to $926bn, and, surprisingly increased slightly to $933bn at the end of Q1 2020. The fundraising in the private equity market in Q1 2020 rose to $133bn, compared to approximately $125bn in Q1 2019. However, there is a substantial decline in the number of funds raising. The industry reached a record low of about 275 funds raising, compared to about 375 in Q1 2019. In line with this development, the industry sentiment remains strong, as 60% of funds target an aggregate capital higher than $1bn. Figure 8 shows the development of dry powder in the industry. There is a record amount of dry powder available at $1,464bn in summer 2019. According to investors in Q1 2020, there is an increase in the commitments in fresh capital which exceed $600mn, but also a substantial increase in commitments below $50mn, showing that commitments within this range are decreasing. Lastly, we have a deeper look into the most common types of private equity, buyout funds and venture capital. Buyout funds account for 34% of the total capital of private equity. The number and the capital involved in equity-backed buyout deals remains stable at $95bn with about 1,100 fund raising capital. Figure 9 compares the returns of private and public equity. Private markets seem to slowly converge to public markets. For capital commitments below ten years, in other words, since the financial crisis in 2008, the returns of buyout funds in the US are almost equal to the performance of the S&P 500 as of June 2019. For the future, it is crucial how resilient and stable private equity will be in such crises compared to public equity to maintain its superior return. Venture capital, which accounts for 20% of PE deal volume, decreased by approximately $10bn in Q1 2020, falling to around $45bn. This level was reached the last time in Q1 2017. Europe accounts for approximately 25% of VC deal volume. Europe was severely hit by covid-19 and the deal volume in Q1 2020 is perfectly on track the reach last years volume again, which was record year by far, as the volume rose from €25bn in 2018 to €33bn in 2019. Figure 7: Development of the AuM of Private Equity from January 2015 until April 2020, Source: Preqin, April 2020 Figure 8: Historical Distribution of Capital Sorted by Dry Powder and Unrealized Value of Investments from December 2009 until June 2019, Source: Preqin, April 2020 Figure 9: Historical Performance of US Buyout Funds Compared with the Performance of the S&P 500 over the Last 30 Years (As of June 2019), Source: Bain & Company, February 2020 Figure 10: Historical Volume of Deal Value in European Venture Capital from 2006 until April 2020, Source: Pitchbook, April Private Debt The implications of covid-19 seem to be largely similar to private equity. However, as seen in the last paragraph, private equity increased its fundraising in Q1 2020 compared to Q1 2019. This is the pure opposite for private debt, as it only raised $14bn in Q1 2020, which is slightly more than half than what was raised in Q1 2019 and marks the lowest number since Q1 2016. Most of this capital was raised by direct lending funds with almost $10bn, followed by special situations with $3.2bn and mezzanine with $1.6bn. Other strategies, such as distressed debt, venture debt and private debt fund of funds in combination raised only $0.2bn, as visible in Figure 11. Despite the low numbers in fundraising, the AuM of private debt reached a new record high at $201bn at the end of Q1 2020, compared to $192bn at the beginning of 2020. Therefore, the industry is on track to increase its volume similarly as it did in 2019. Figure 12 shows the continuous increase in the AuM of the industry from 2015 until Q1 2020. The average performance of private debt remains stable compared to previous years. Direct lending on average yields about 7% for one year and approximately 5% for a duration of five years. Mezzanine variates between 11-12% depending of the time horizon of one up to five years. Distressed debt is more volatile compared to the other two strategies, as one year typically yields only 4%, for three years the IRR jumps to 9% and for five years the return falls back to 5%. Figure 13 shows the available dry powder sorted by the strategy. Approximately a third of the capital in the industry is not committed yet, which will certainly help during such a crisis. However, it is likely that the capital commitments are simply delayed. The crisis has an effect on the investor sentiment and causes investor to try to reduce their risk, which is shown in fact that 73% of investors are planning to commit capital to only one fund, compared to 62% in Q1 2019. The percentage number of allocations to more than 4 funds fell from 38% in Q1 2019 to only 27% in Q1 2020. Figure 11: Distribution of raised capital across different strategies in Q1 2020, Source: Preqin, April 2020 Figure 12: Development of the AuM of private debt from January 2015 until April 2020, Source: Preqin, April 2020 Figure 13: Distribution of the Capital Across Strategy and the Division into Unrealized Value and Dry Powder (as of June 2019), Source: Preqin, April 2020 Real Estate The real estate industry reacted similar to private debt and less like private equity. The major difference addresses the fundraising in Q1 2020. While private equity increased the capital raised even more, both private debt and real estate lost a substantial amount in new funds raised compared to previous years. Real estate fundraising fell to $18bn in Q1 2020, which is a huge decrease compared to last year’s Q1 with $51bn raised. This is a new negative record within the last five years after another already record low in fundraising in Q4 2019. The number of funds raising also collapsed to only 51, while it was always more than 80 in the previous quarters. Figure 14 shows the allocation of raised capital in Q1 2020 to the different strategies, in which value added consumes $10.2bn. Other strategies, such as debt and core account for $4.2bn and $1.7bn in total, while the remaining strategies, core-plus, opportunistic, fund of funds and co-investment are responsible for less than $1bn each. On the AuM side, the future looks brighter, as observable in Figure 15. The AuM of the industry rose to a record level of $297bn in April 2020. The growth in Q1 of the AuM is in line with the quarterly gain from last year, which was a record year, as the industry grew from $219bn in January 2019 to $281bn in January 2020. The number of funds also slightly increased to 939 compared to 916 at the beginning of 2020. However, the industry may face some issues with capital in the future, as the fundraising dropped to a substantial lower level and most of the capital available currently is committed, as shown in Figure 16. Despite the currently unfavourable environment of real estate, it remains the most profitable industry aside from private equity in private markets, which may lead to an increase in future inflows again. Figure 17 shows that the return of private equity lies between 14-17% for the duration of one up to ten years commitment. Real Estate is the second-best performing industry with an average of 8-10% depending on the duration, while private debt strictly returns less than real estate. Infrastructure slightly outperforms real estate for a duration below three years but return significantly less afterwards.  Figure 14: Distribution of the Raised Capital in the Real Estate Market Across Strategy, Source: Preqin, April 2020 Figure 15: Development of the AuM of the Real Estate Industry from January 2016 until April 2020, Source: Preqin, April 2020 Figure 16: Capital Called up and Capital Distributed from 2009 until H1 2019, Source: Preqin, April 2020 Figure 17: Comparison of Returns in the Private Markets from 1 Up to 10 Years, Source: Preqin, April 2020 May Outlook 2020 by Aquila Markets The sense of dissonance between financial markets and the real economy continues apace. The data flow from the real economy remains shocking. Warnings abound from CEO’s not simply about plans to survive the current lockdown, but the difficulty of reopening businesses that rely on people being “close together” whether they be in hospitality, travel and leisure, or general workplaces. How can we social distance at work, and as one former colleague asked me, in dealing rooms!? How can restaurants survive with tables set 6 feet apart? How are we going to feel about being waited by someone wearing a mask and gloves?!? The critical factor as I have discussed before, will be testing, and tracking those who have been tested. The narrative that a “vaccine” will end this situation is too simplistic; mutations of the virus will mean we shall need continual vaccinations, as people around the world do for regular Flu (which is a virus too).   Whilst I have referenced how we work, WHERE we work is an important consideration too. Jess Slaley the CEO of Barclays highlighted this morning that he can see bankers working out of branch locations and not at centralised offices in London or elsewhere. This upcoming theme of “sell cities, buy towns” is important. Cost of office space is lower, people can typically drive to and park (self isolate on commute), and would be stimulative for local economies. By contrast, the outlook for global cities with expensive rents and complex public transportation facilities, looks poor. It is no surprise that our old friend Tesla stock is enjoying such a surge once again; owning an electric vehicle to drive to work over a relatively short distance, is surely going to appeal to both employers and employees as we emerge from lockdown. I also like VW as a company covering many brands who can produce hybrid electric vehicles at multiple price points.    How people behave as we come out of lockdown is interesting to note. I read a good article in the NY times entitled “China’s Factories are back. Its Consumers are not”, in which it highlights the change of behaviour in consumer’s spending patterns. https://www.nytimes.com/2020/04/28/business/china-coronavirus-economy.html The following passage summed this up perfectly (highlighting by me) :   Harry Guo, a 22-year-old Shanghai bartender, said that he used to spend any extra money he had on vacations to other cities in China, but had been stunned by how many people had trouble affording even groceries during the pandemic. Now he does not worry about keeping up appearances when he goes out, seldom buying new sneakers or other indulgences.   “As long as the money is in your wallet, there is a strong sense of security,” Mr. Guo said. “It just has to lie there, you don’t have to spend it, you feel comfortable just opening the wallet and seeing it.”   It is clear that preference for saving over spending, and spending on essentials and less on “stuff” is a key narrative. If people can find a way to travel safely, they surely will. Will they go and buy a new coat when they already have several? Less likely. Plus, travel is likely to become a very regulated activity, carrying a passport of immunisation alongside a regular passport, being checked at airports. Also airport retail is likely to diminish – both authorities and people will want people to arrive, be checked, get on and off the plane as fast as possible and out of the airport. The outlook for retail outlets in the way we have seen in the past will change.   And yet…I remain very bullish equities, which I see increasingly as a shorter term view with a potential for explosive upside. As I wrote 3 weeks ago, I changed my view thinking  we could see equities to new highs, and quickly, and I remain of that view. It has been pointed out to me, that earlier in this crisis I mentioned that we had seen the high in equities for a very long time indeed, which is true; at the point I was looking through the lens of the economic destruction and changes we are likely to face, especially in the West. I still feel that acutely, but from a trading point of view there is great risk reward for the long trade, driven solely by the actions of central bankers and policy makers throwing gigantic amounts of money at a problem that hasn’t started to be fixed yet.    We await the FOMC today and the ECB tomorrow. Both will be fascinating for different reasons. The FOMC statement will require some work, given what they have done over the past 6 weeks since the last meeting on March 15! Interestingly, while the Fed balance sheet continues to explode higher, they have yet to buy any Junk bonds; the mere threat of them doing so, coupled with 2 Trillion USD of monetary expansion, has been enough to get the market to do it for them. So the JPow message today, and the Q&A, will be key. How big do they see the balance sheet getting? What else can they buy, including equities? How do they envisage unwinding this.    As for the ECB, the chance that they act in some way, either through an additional rate cut or through expansion of both pace and scope of asset buying, seems to be underpriced. As usual the ECB governments are incapable of concrete action (decisions are only ever made at “1 second to midnight”), and the debate of loans vs grants for the peripheral nations speaks to the debate at the heart of further European integration; sharing of liabilities. With Italy downgraded overnight, will Lagarde look to send a message to the EU that they need to act?   Critically – we are reaching the limits of central banks’ ability to produce the outcomes they have for the past 30 years. Their action, as I mentioned for many years, has been a hugely depressive of volatility, which has allowed for the rise of “portfolio efficient” strategies such as risk parity that rely on the action of central banks to drive up bond prices when risk assets fall. With Bond prices nailed to the ceiling, what can they do beyond continued colossal balance sheet expansion? Naturally this rotation from control of policy to elected politicians will create more volatility, as they don’t act independently but with bias. We can make the case, that we have seen the low in realised volatility for a very long time. Put another way, maybe we could see new highs in stocks, but will NOT see new lows in realised vols.   This brings me full circle to why I think equities can rally hard now, but in H2 of 2020 the story can be very different. Who buys stocks? The wealthy or mass affluent. Where are they? At home, with groceries in the fridge and super fast broadband so they can carry on working. They aren’t taking trains, they aren’t going out. They are isolated from the real fear of the virus. Equity price strength will encourage more FOMO buying in a rally that has been extremely narrow, centred around the large cap “stay at home” stocks, which will feed on itself. BUT, volatility in this rally will remain.   As for what is coming, the US Presidential election looms large. The China backlash is coming, and Trump knows that this is a way he can regain the America first theme. Additionally, what happens when someone points out to The Don that the Fed swap lines, funded defacto by the US taxpayer, are bailing out borrowers in USD the world over. What happens when tariffs and directed trade policy results in a collapse in global trade and a defacto reduction in global USD supply, exacerbated by low commodity prices? What happens when China decides to vastly reduce its holdings of UST’s? What happens when the virus returns in the Autumn? I am not going to pretend to predict all of the above, except to say… I like the risk upside for now, quickly, but vol isn’t going away, and we better get used to it. Trades :   SP500 – short term risk of a pull back to 2700/50 zone. 2730 held like a charm last week before this next leg up – a pullback into this zone would set up nicely for a test of 3000-3100 over the next 7-10 days.    EURAUD and AUDUSD – the strength of the AUD trend up with the recovery in copper has been very solid. With short term risk for risk to pull back I see some consolidation for AUD short term, but notice that EURAUD has traded back to the Feb high at 1.6575 and held. Given the original call to sell was at 1.7800, I think taking some profit here makes sense wait for next set up.   USDJPY – we have been watching the divergence between USDJPY and US rates, feeling USDJPY can trade lower to come back into line. We have finally broken and closed below 106.90 double bottom support. Stop above 107.50 now. Good luck all. Figure 18: Fed Balance Sheet vs S&P500 in the Last 5 Years, Source: Aquila Markets / FRED, April 2020  Figure 19: S&P500 and Its Inflection Point, Source: Aquila Markets, April 2020 EURAUD – its been emotional… time to take the money and run. Figure 20: EUR-AUD Exchange Rate, Source: Aquila Markets, April 2020 USDJPY – rate convergence play in force….. Figure 21: USD-JPY Exchange Rate, Source: Aquila Markets, April 2020 The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer. Chris Eagle Aquila Markets E : chris.eagle@aquilamarkets.com M : +447712885718 Chris is an experienced executive who runs his own consultancy service which focuses on business development, market structure, financial market analysis and training. He worked on the sell-side for twenty years. He left Jefferies in 2015, where he worked in the Global Foreign Exchange and was Head of FX product distribution. This perspective is neither an offer to sell nor a solicitation of an offer to buy an interest in any investment or advisory service by Stone Mountain Capital LTD. For queries or for further information around our research and advisory services please contact email: research@stonemountain-capital.com under Tel.: +442037228175. STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). In private assets, we advise 10+ sponsors and general partners across private equity, venture capital, private credit, real estate, capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. 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