Hedge Fund Woes Can't Diminish Banner Year for Long-Short Trades

  • Funds snagged gains wagering on technology companies
  • Volatility, easing correlation helped long-short strategies

Investors are finally warming up to an equity strategy that’s been lagging for the last six years.

Long-short hedge funds, which place bullish and bearish wagers on individual stocks, are on track to top the Standard & Poor’s 500 Index for the first time since the 2008 financial crisis, according to an index by Credit Suisse Group AG.

While the S&P 500 has struggled to hang onto its gains all year, long-short fund managers were able to differentiate by wagering on winning industry groups within technology, according to Mark Connors, Credit Suisse’s global head of risk advisory. This year’s long-short returns are poised to top every other strategy tracked by the firm.

“Macro factors still weigh on markets, but instead of everything lifting as
in 2013 and 2014, you’ve had some segmentation by sectors this year,” said New York-based Connors. “Equity long-short funds picked up on that.”

It’s been a rough year for hedge funds overall, with Och-Ziff Capital Management Group LLC and Mason Capital Management among those seeing redemptions. One strategy seeing returns come through is equity long short: KKR & Co. and Goldman Sachs Group Inc. bought stakes in funds focusing on those bets, while Newbrook Capital Advisors and Aroya Capital have posted gains of at least 11 percent. Aroya also employs a volatility arbitrage strategy.

The prospect of higher volatility and interest rates are also helping, says Christophe Caspar of Russell Investments. For six straight years, long-short funds have trailed the S&P 500 as stimulus from central banks worldwide crushed volatility. Now, with the Federal Reserve poised to lift borrowing costs, price swings have returned, helping dissolve the lockstep movements in stocks.

The Credit Suisse Long/Short Equity Index climbed 3.7 percent this year through October, as the benchmark gauge for U.S. equities advanced 1 percent over the same period. The Credit Suisse measure will be updated to include November’s performance on Dec. 15th.

Consumer discretionary, tech and health stocks have rallied this year, while energy and commodity producers have slumped. Long-short funds went overweight outperforming sub industries like Internet retail, Internet software and services shares this year, helping them boost returns, Connors said.

Performances by long-shorts funds are also diverging -- the spread of returns between the top and bottom quartiles has widened from 10 percent last year to as high as 20 percent in 2015, data from Credit Suisse show. That makes it easier to identify long-short managers who are capable of navigating through a period of bigger price swings, according to Caspar.

“The tail risks are higher,” said Caspar, the London-based chief investment officer of multi-asset solutions at Russell, which oversees about $240 billion. “In a higher volatility regime, there’s also much more opportunity for those skilled managers in the long-short space who can make money.”

Bigger price swings have spurred hedge-fund managers to boost short bets and shift investments more frequently. The average short interest on S&P 500 companies surpassed 3 percent in November for the first time since 2011, data by research firm Markit show. Trading has also increased -- a 29 percent jump in turnover in the third quarter contrasts with six years of declines, Goldman Sachs said in a report last month.

While hedge funds cut back on risky bets heading into December, the gap between top and bottom performers could shrink starting next year, said Amir Madden, a portfolio manager of equity long-short funds at GAM, which oversees about $127 billion.

“In terms of the range of returns, there was an unusually wide dispersion,” New York-based Madden said. “There will be some performance chasing, but you could also see funds that have done poorly may begin to look more interesting once the dust settles.”

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