Silver as an investment

World’s Most Bearish Hedge Fund Says Active Manager Capitulation Is “Getting Close”

While Russell Clark’s Horseman Global may no longer be the most bearish it has ever been (it was over 100% net short in June), and has since trimmed its bearish bets to “only” 84% net…

… it certainly remains the most bearish $1 billion+ hedge fund in the world. Which means that in August, when the S&P soared back to record high highs, and global stock markets soared, Horseman’s LPs were less than excited with the fund’s performance. Sure enough, as Clark writes in the latest hedge fund letter, “your fund dropped 4.94% net this month. Losses came from the short book, the FX book and the bond book.

The mea culpa continues:

It was a poor month for the fund, but probably overdue. The MSCI world index is up 3% this year, while MSCI emerging markets are up nearly 12%. Many of the dollar weakness trades that I have had on this  year reversed in the final days of the month as the Federal Reserve talked up interest rate rises.

So is Clark finally ready to throw in the towel and take the blue pill? Not even close, although he does admit that active managers are suffering:

We have made some changes to the portfolio. There are signs that China has had some success with its policy of closing capacity in heavy industry, particularly in coal. This has made me far more nervous about commodity related shorts, and so we largely exited the remaining positions in the short book. In their place we have shorted staples and Reits. I like Reits and staples as shorts as many of them have poor financials, and tend to fall when bond yields rise, offering a nice hedge on my long treasuries positions.

 

So after 8 months of hard work in 2016, with a few wins and a few losses, here we are with a fund that has basically gone nowhere. This is a sorry state of affairs that has been repeated not only at hedge  funds, but for most active fund managers. Why should investors bother giving their hard earned cash to active managers, with their higher fees and poor performance. This is a view that is gaining more and more traction in the industry. Active fund management, with hedge funds by definition being the most active, has become an area to be avoided.

 

I hear this argument more and more, and I have some sympathy for it. However it seems logical to me that a market that is heavily skewed to one area will naturally favour passive investors who remain fully invested no matter what, and when this imbalance unwinds active managers should outperform. In the TMT boom, active fund managers did their best to avoid buying overpriced stocks, but generally their underperformance became so extreme, that they either left the industry, or eventually succumbed to the madness and bought into the bubble – typically at the worst point. However, after the bubble burst active fund managers massively outperformed, at least until 2008 or 2009. However from 2009 onwards, active fund management has been going through a prolonged period of underperformance.

And, as we have said for the past 7 years, they can thank central bankers for destroying “markets” as we know them.

So what happens next? Clark believes that any moment now, the moment when the final bear capitulates is “getting close.”

One of the curious features about long periods of outperformance of one style or another is that ultimately everyone is forced in. Sometimes this happens through capitulation by previously sceptical investors, or sometimes it happens through pure greed as fear of missing out takes over. The big question is, how close are we to that moment? I think we are indeed getting close. Goldman Sachs data on hedge funds show that top 10 positions for average hedge funds make up 70% of long positions.

 

Longs tend to concentrate as market breadth narrows, and funds are forced into fewer and fewer winners. Total level of short interest is beginning to fall according to NYSE data. And large short biased funds have had a very tough time of it. Against this bonfire of the shorts, more and more investors are moving to passive strategies, or even structured products.

In conclusion:

Despite the rally in markets, my preferred measures of SPX versus TLT, S&P 500 in Yen terms, and JPY/KRW exchange rate are all still in bear trends. I feel and see capitulation all around me, while not much has really changed. Your fund remains long bonds and short equities.

Good luck. Finally, this is Horseman’s monthly P&L looks like: