Long/ short equity hedge funds have been having a solid year as the rotation from growth into value stocks picks up steam. Hedge funds following the strategy were up by an average of 6% for the first two months of the year, according to the latest HFM Insights. The firm adds that it was one of the industry’s best Februaries in decades.
Value outperforms growth
For the first time since the pandemic started, value stocks have been outperforming growth names as hedge funds rotate out of tech and into cyclicals. HFM said the growth-to-value rotation in February signaled that hedge funds are actively positioning their portfolios for economic recovery after the pandemic.
Value stocks rallied as COVID-19 vaccine distribution continues and the number of hospitalizations continues to fall. The market is now optimistic about the economy reopening. Value investors have been waiting patiently for a recovery in the factor after a decade of underperformance. Before the rotation into value started late last year, the gap between growth and value reached “extreme levels” and was “nearing a three standard deviation event,” according to T. Rowe Price.
Opportunities for value funds
Stock pickers should benefit this year as much value remains to be recovered. As the rotation is still in its very early days, value stocks are still trading at steep discounts.
The firm added that value funds saw a recovery in late February as blue-chip stocks beat out tech-heavy growth names amid a sluggish recovery. During the month, fund managers sold off tech stocks to rotate into cyclicals, and HFM predicts that this trend could be here for at least the rest of the year.
MAN Group’s FRM fund of funds division said the alpha landscape was perfect for long/ short equity funds during the first three weeks of February. The last week of the money saw a significant risk-off move as stocks shifted lower amid a sizable rotation out of tech stocks and into cyclicals. That led to value stocks outperforming growth.
Long/ short equity hedge funds surged in February as volatility and dispersion remained elevated. The HFM Global Equity Index gained 3.7% during the month, its best February performance in more than 20 years.
Hedge funds rotate into value and out of growth
Low price-to-earnings multiples and high dividends often characterize value stocks, and they have underperformed since the financial crisis. In the last several years, hedge funds have significantly boosted their allocations to growth stocks, sending value stocks lower and lower over time.
However, this trend is shifting as valuations recover from pandemic lows and approach record highs. David Amaryn of Balchug expects a volatile year and is positioning his fund’s portfolio with defensive, cyclical stocks at attractive valuations. He noted profit-taking in growth stocks in February, and that’s when they shifted position. He feels the fund now has “a good mix of value/ cyclical stocks and high-quality growth stocks.”
Platinum Asset Management’s international fund had a difficult beginning to 2020, ending the first three quarters of the year with a 9.4% decline due to its underweight position in growth names. However, the fund has come roaring back to rise 7.8% this year due to its positioning in cyclicals. In their letter to investors, Platinum portfolio managers Andrew Clifford and Clay Smolinsk said a change in the “real world” is a shift away from monetary policy toward fiscal policy “after decades of restraint by governments,” which favors “real companies over virtual ones.”
A strong earnings season also drove outperformance among long/ short equity funds as reopening themes boosted companies. Deleveraging spurred on by the retail trading chaos in January reversed in February adding to the positive performance. Contour Asset Management bet on growth in home buying, which boosted its return 9.6% by the middle of the month before cutting back to an 8.8% gain.
Senvest Management, which had invested in GameStop, was up 15.3% in February after exiting the retailer in January. Year to date through late March, the fund is up almost 60%.
Managed futures funds also recover
Managed futures funds have rebounded from widespread losses in January with a 3% February gain. The average CTA fund was up 2.8% year to date. The biggest trend-followers led the recovery as ISAM, Crabel Capital Management, Transtrend and Graham Capital Management all notching more than 3% gains in February.
This year has also brought a broad-based selloff in the bond market, and yet, managed futures funds have done well. MAN Group’s FRM fund of funds said that there were some doubts about whether CTAs could generate returns when the bond market is selling off, but February proved that they could, as many funds posted solid returns.
Rising commodity prices have also given CTA funds a boost this year. Base metals and bond futures shorts boosted Swiss manager Quantica to its second-best month in 16 years. The fund’s Managed Futures Program returned 7.1% and has gained 8.8% year to date. Exposure to commodities contributed 3.8% of the aggregate performance, while bond exposure accounted for 4.2%.
Tapping into commodities and the bond selloff
Quest Partners climbed 13.3%its best return in two years, bringing its year-to-date return to 7.7% after tumbling in January. Roy G. Niederhoffer gained 10.5%, while Transtrend returned 4.7%. Across the CTA landscape, most of the profits came from long commodity and short bond positions.
Managed futures funds could start to see investor inflows, as Lyxor Asset Management explained that they are a great way to benefit from surging inflation expectations or real bond yields through their currency and commodity exposures. Luxor predicts that commodity prices will continue rising for at least the next two years, which would mean good things for CTAs.
The growth of cryptocurrencies and their steady movement into mainstream investing has been another focus in the financial markets. Lyxor said some CTA funds have started to diversify their portfolios with cryptocurrencies and other exotic assets. Still, at this time, the exposures are too small to have a meaningful impact on performance.