Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
02/11/2011
Comment: Stephen Oxley
Stephen Oxley is MD at Paamco Europe. He is responsible for managing Paamco’s global client relationships and is a member of the firm’s investment oversight
committee
Fundamental equity managers are finding life difficult. An ironic and waggish photograph currently doing the email rounds shows a man in a suit standing on the street waving a placard, like a
white-collar anti-capitalist demonstrator – “End Market Correlation” his banner proclaims. An easy (if somewhat obscure) jibe at Occupy Wall Street. But the disgruntled trader
– who surely must be a long/short equity portfolio manager – makes a justified and heartfelt stand.
Equity prices have been moving in lock-step now for several months. Correlation between individual stocks – the tendency for a rising or falling tide to lift or drop all boats together – has gone up significantly, making equity trading more of a directional punt and less of an empirical pursuit.
When equity markets rise or fall and their constituents move together, it is difficult for a stock picker to make money. Long/short equity hedge funds tend to do better when correlation is low or when it is falling. If market sentiment is indiscriminate, ideas, analysis and research can count for little and fundamental traders get frustrated. Why should a company that is well-managed with a clean balance sheet, sell-off as much as one in the same sector that is badly managed with large debts? Yet, such are the characteristics of the macro-driven environment which has prevailed in recent months. As politicians have dithered over what to do about the Eurozone crisis, so some active market participants have been burned.
Correlation, like volatility, is cyclical. And recently the two have gone higher together. The correlation of the S&P 500 has risen steadily since May this year and has corresponded with a rising VIX, with both peaking in the third quarter. The recent period has been a particularly difficult one for long/short equity because correlation and volatility have together conspired against the strategy. Poor alpha production (picking the best stocks long or short) has been compounded by negative beta (difficulty in timing market exposure).
Fundamental traders want to see a return to higher levels of cross-sectional volatility (ie lower correlation) and a less macro-driven market environment. The managers who have done best have tended to be those who incorporate macro-awareness into their portfolio construction, with some for example implementing or developing top-down tools to guide decisions about net and gross positioning. Nonetheless, the strategy remains one where the most important decisions are those that start from the bottom with fundamental analysis.
The contrast is that while the protesters on Wall Street and in other financial capitals seek an end to inequality and a fairer distribution of income, the stock pickers of Connecticut and Mayfair hope for an end to the egalitarian regime that has prevailed in the markets. In the end the joke may be on the traders rather than the lampooned protesters. But perhaps both will have their way; hedge fund manager incomes are reportedly falling and as we edge towards a resolution of the European sovereign debt crisis we may well see a return to more fundamentally driven markets, where rational valuation and fairness prevail.
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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