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.
STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.88
Our in-house strategies in credit, equity and fund of funds, as measured by our indices, have performed better in the first half of the year than their traditional and alternative peers. Tactical trading is still lagging due to the struggling performance of the actively managed altcoin strategy this year mainly driven by falling bitcoin prices. Equities are the top performing and the bucket that has the most representatives in the top-5 performing table, followed by credit/fixed income strategies.
STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.81
Indubitably, the cryptocurrency market has caught the attention of investors and traders, who are engaging vigorously due to its volatile nature. The crypto market has reached a market capitalisation of ca. $400 billion, half of which is in Bitcoin ($140bn) and Ethereum ($70bn). Crypto markets are affected on a large scale by regulatory and sentiment factors, which makes technical analysis desirable, hence many CTAs that apply such techniques have added cryptocurrencies in their trading portfolios. One of the theories that could reveal patterns is the Elliott Wave Principle, developed in the late 1920s and believing that the swings of market psychology appear in similar repetitive patterns, which Elliot classified as waves. The waves were essentially the consistencies of investors’ reactions to external factors. Despite the principle’s popularity, its difficulty to be applied should be stressed out as investors attempt to analyse the patterns. The divergence in opinions about the Bitcoin’s price projection highlights the predicaments in applying theories and considering the unregulated nature of crypto markets all theories may lead to a worth of zero. The main and biggest issue that technical traders face is defining the duration and length of the first wave and then to apply the rules, therefore many traders that analyse the same horizon may end up with different signals. The other hurdle is the applicability of the principle in cryptocurrencies. This perspective will consider it applicable due to the sentiment driven Bitcoin, although this may change in the future with the inclusion of more computerised trading. For the purpose of this perspective, we will examine different time horizons and the most recent crashes and rallies of the Bitcoin price.
Hedge funds started 2017 under pressure and the overall industry’s model was in question. Performance and fees were the main topic of debate among investors at the beginning of the year, but hedge funds managed to pull a strong year with no down month. Despite losses from some large managers, the industry overall generated strong returns according to HFR data attracting more capital. Per HFR, total hedge fund industry AuM increased by $59bn to $3.21tr, the sixth consecutive quarterly record for total industry AuM. The inflows suggest a sign of regained optimism, but the industry will need to sustain its performance long-term in order to regain its calibre. The oxymoron of the industry is the fact that equity hedge were the best performing strategies amongst hedge funds but suffered the biggest outflows. Macro, CTAs and multi-strategy attracted more capital this year, and given the outlook for more volatility and less central bank intervention, investors target further allocations in those sub-sectors.
Stone Mountain Capital Strategies
2017 was the year producing the strongest return for hedge funds since 2013 and second best since 2009. Stone Mountain Capital strategies outperformed in last year’s environment across all asset classes. Credit was the only strategy underperforming its peers, caused by yield compression in the direct lending space. One, out of only three negative strategies was in credit, while the other two, were CTAs that struggled amid the low volatility and trendless environment. Despite these two strategies, tactical trading was overall the best performing strategy with strong returns generated by discretionary global macro and cryptocurrency. Equities enjoyed a very profitable year and Stone Mountain Capital’s mandated equity hedge managers produced astonishing returns, beating their traditional and alternative peers. Finally, fund of hedge funds recovered from their 2016 losses, surviving while the industry’s model is evolving.
Figure 3. Stone Mountain Capital In-House Indices vs. Major Benchmark Indices Hedge Funds and Long Only in 2017, Stone Mountain Capital Research; SMC strategy indices are not investable products but are used as indication of our managers' performance and are calculated with the equally-weighted method.
STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.69
The most popular and controversial topic this year within finance and tech circles is the rise of Bitcoin and crypto markets. Bitcoin jumped into mainstream and financial products like futures, options, funds, certificates, ETNs, ETFs are being designed to allow exposure to cryptocurrencies. The last one and a half month, we evidenced a huge growth of the crypto market, with its capitalisation surpassing $561bn from $182bn on the first day of November. The crypto market metamorphosed into a market bigger than CTAs, a $343bn well-established alternative investment market. Crypto market, according to CoinMarketCap, consists of 1360 cryptocurrencies, but Bitcoin and Ethereum account for around 67% of this market. Bitcoin market cap became almost three times bigger within two months, being a $318bn market now, with its price rising from $6,750 in the first day of November to $18,000. Ethereum was the fourth largest coin market in 2015 behind Bitcoin, Ripple and LiteCoin, but as we approach the end of 2017, the $66bn Ethereum market cap is nearly double of Ripple and Litecoin’s capitalisation combined.