Alternative Markets Review 2018
2018 started as strongly as it finished in 2017, but spikes in volatility caught hedge funds unprepared and highlighted the weaknesses of the industry. The rest of the year continued in the same pattern with major political risks adding to the problem such as Brexit outcome, European elections, end of quantitative easing and trade war. The fourth quarter and equities sell-off since October ruined hedge funds hopes to rebound and sank them deeper into their losses. Event-driven and equity hedge strategies were the worst performers among hedge funds, followed by systematic CTA and macro strategies. For our in-house strategies, the scenery was slightly altered as the worst performing asset class was tactical trading. Underperformance of cryptocurrency and CTAs are the main drivers of the underperformance compared to other indices, despite the strong performance of our global macro and market neutral strategies. Equities globally suffered severe losses, similar to the majority of our in-house strategies. Our niche equity strategies focusing on disruptive techno-
logies and directors' dealing though posted strong returns and constitute our best two performing strategies for 2018, consequently leading to a relative outperformance of peer indices. Direct lending and structured credit enjoyed a good year assisting in our credit index's outperformance. Only two out of eight strategies posted losses for a year, when equity and credit largely disappointed their investors. Overall, our cross-asset and single manager index posted losses for the year due to our tactical trading underperformance, but still performed better than the majority of the individual indices.
The above computations are made on arbitrary assumption of 2% as a risk-free rate .
Sortino Ratio considers the respective Credit Suisse Hedge Fund Indices as minimum acceptable rate. It is computed with monthly returns.
Sharpe Ratio is computed since inception so investors should consider the differences between the lifetime of the strategies and indices before drawing investing conclusions. It is an annualised figure.
SMC strategy indices are not investable products but are used as indication of our managers' performance and are calculated with the equally-weighted method.
Data sources for indices:
S&P 500 - https://ycharts.com/indicators/sp_500_monthly_return, BofA ML US Corporate Master Index - https://fred.stlouisfed.org/series/BAMLCC0A0CMTRIV, HFRX indices - https://www.hedgefundresearch.com/family-indices/hfrx, HFRI indices - https://www.hedgefundresearch.com/family-indices/hfri, Credit Suisse Hedge Fund indices - https://lab.credit-suisse.com/#/en/index/HEDG/HEDG/performance, UCITS indices - http://www.ucits-alternative.com/, CBOE Eurekahedge RV Volatility Index http://www.eurekahedge.com/Indices/IndexView/Eurekahedge/641/CBOE_Eurekahedge_Relative_Value_ Volatility_Hedge_Fund_Index
Past performance does not guarantee future results.
Some of the static themes of January – gradually worsening global data, especially in the Eurozone, US government shutdown, China trade talks, continued marking down of growth expectations by IMF and others, Brexit logjam, continued Fed “row back” – have finally started to crack with the Government Shutdown in the US being temporarily ended.
This is significant for a number of reasons – initially it was the Trump White House (facing increasing criticism of simply not understanding how the world ACTUALLY works) – being shaken out of their Shutdown stance by a gradual increase in pressure on the infrastructure and the “way things work”. Wilbur Ross’s comments about unpaid federal workers “taking out loans” to cover their shortfall in their income by not being paid was clearly seminal, as was the issues around NY area airports last Friday. Have we seen “peak-Trump”? He has blinked and his right-wing supporters will never let him forget it.
The Fed also “blinked”, initially over rate hike path as even the most hawkish of FOMC members changing their tune. Discussions are now building as to potential row back from the pre-determined USD 50mio / month balance sheet reduction program. The oft shown chart of Central bank balance sheet size plotted against The Fed is below. The B/S size matters in the US.
This week really matters, as is a catch up in US data releases that have been postponed to the shutdown. An ad-hoc schedule of releases is likely over the coming days/weeks – this increases the possibility for data surprise and variance in markets. Trade talks between China VP Liu He and Lightheizer this week. European Q4 GDP data this week, and raft of global inflation data too.
Could we see a blink in Brexit? The chance of a deal happening is increasing (although Ref2 has been and does still remain central case). The experience of the Brinksmanship in the US is lesson for what happens to complex economies when a multitude of agencies simply stop working. Analysts have maintained that a “no-deal” Brexit was voted for in the referendum, but given the Government has not prepared correctly for it, it is understandable that Parliament rejects what could be chaos. It would be a disaster for Ireland too, given the economic links with the UK. The Irish PM has overreached over the backstop, and is holding the line. But Europe will recognise that they need a deal just as much as the UK does. News flow will remain high this week.
There is an expectation that a resolution of many of the above issues is going to cause asset markets to resume their moves to the upside. The global economy is slowing – it could well be that 2018 was “as good as it gets” for this late cycle. The long held theme of globally weakening housing on a broad basis is continuing.
Trades and Markets
The core MO for the year remain selectively timed, funded, long gamma plays across asset classes but especially in FX. Price action this year – generally will come in waves of activity, followed by periods of relative calm. We have seen this manifesting since September, with vol zenith being reached at the end of 2018, followed by a relatively calm period where implied vol in FX, generally, became low and expensive relative to realised vol – this is ALWAYS the worst scenario for investors – vol are hard to buy (they don’t realise) and hard to sell (you are always worried about the risk adjusted returns of selling low implied especially in an event risk laden world). This is why funded spreads are such an important part of the trader’s tool box this year.
In the past week, being outright low has been less than successful as vol have sold off hard, but using spreads has mitigated this. Nevertheless, we have seen pockets of variance appearing in certain pairs, often generated by data or new wise releases.
In macro markets – main focus remains on SP500 as major proxy (technically many FX pairs charts have been damaged with the flash crash moves earlier in January and the difficulty of knowing exactly what lows were). ES1 has dug deeper into the resistance zone – but note the lower daily last week; with Friday’s high at 2672.50 failing to trade above the post Xmas Eve low rebound high at 2677.75 Focus on support zone at 2623/33, a break of which would herald a deeper test into mid 25’s. Also note that USDJPY has topped out at 110.00, US 10years at 2.80, oil 54.00 etc.
USDCAD gamma offers value – spot is at an inflection point – daily double bottoms 1.3180, 100dma 1.3206, RSI’s oversold, vol on the low and a higher spot will equate to higher vols. Break lower in spot – gamma is likely to perform but vol will be supported off this vol base.
Gamma trades focused on from the Fx side – USDCAD(mentioned above), EURAUD, CHFJPY, USDJPY. Volometer is attached below. As always a mine of information.
GBP cross vol have been pushed lower with the higher spot. Reaching value levels? Selective gamma plays could be a play for those involved (or for those who have caught the Sterling rally to hedge).
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.
Chief Executive Officer
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Chris Eagle has held sales and trading roles in Foreign Exchange and Fixed Income businesses at Investment and Commercial Banks over his twenty plus year career. He spent much of his early career at Morgan Stanley, both in New York and London, before spells at RBS, UniCredit and CIBC. His recent roles have included Managing Director at Jefferies, and Global Head of FX for the broker-dealer firm, Marex Spectron. Aquila Markets acts as a consultant to a number of buy and sell side firms across various aspects of finance. Chris holds a BSc degree in Biochemistry from the University of St. Andrews.
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Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London. We are advising 30+ best in class single hedge fund and fund of fund managers across equity, credit, and tactical trading (global macro and CTAs). In private equity and private debt, we advise 10+ general partners across the sectors real estate, infrastructure / real assets and capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. As per 26th November 2018, Stone Mountain Capital has total alternative Assets under Advisory (AuA) of US$ 52.8 billion in hedge funds and private assets. Stone Mountain Capital has arranged new capital commitments of US$ 1.42 billion across hedge fund, private asset and corporate finance mandates and has been awarded over 20 industry awards for research, structuring and placement of alternative investments.
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This research may contain forward-looking statements concerning business, operations and financial performance. Any statements that are not of historical facts may be deemed to be forward-looking statements. You can identify these forward-looking statements by words such as "believes", "estimates", "anticipates", "expects", "plans", "intends", "may", "could", "might", "will", "should", "aims", or other similar expressions that convey uncertainty of future events or outcomes. Forward-looking statements include statements regarding our intentions, beliefs, assumptions, projections, outlook, opinions, analyses or current expectations concerning, among other things, results of operations, financial condition, business outlook, the industry, sector or region in which we operate or for which we provide research and the trends that may affect the industry, sector or region or us. Although we believe that we have a reasonable basis for each forward-looking statement contained in this research, we caution you that forward-looking statements are not guarantees of future performance. All of our forward-looking statements are subject to known and unknown risks, uncertainties and other factors that are in some cases beyond our control and that may cause our actual or our research results to differ materially from our expectations. Except as required by law, Stone Mountain Capital LTD undertakes no obligation to publicly update any forward-looking statements for any reason after the date of publication in this research, our website, or on linked websites, whether as a result of new information, future events or otherwise.
Investments in alternative investments are speculative and include a high degree of risk. Investors could lose their entire investment. Past performance is not necessarily indicative of future results. The risk of loss in trading interests can be substantial. You should carefully consider whether such trading or investment is suitable for you in light of your financial condition. Alternative investments are suitable only for persons who are able to assume the risk of losing their entire investment. Alternative investments often engage in leveraging and other speculative investment practices that can work against you as well for you; may increase the risk of investment loss; can be highly illiquid; may have restrictions on transferring interest; may have no secondary market nor is one expected to develop; are not required to provide periodic pricing or valuation information to investor; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds or other investment vehicles; can have volatile performance; may be subject to substantial fees and charges for management, performances, advisory and other fees compared to other investment vehicles, and these fees and charges can offset profits. Alternative investment managers have total trading authority over their funds. Some portion of alternative investment trades may be executed on foreign exchanges.
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