After a miserable 2018, hedge funds are starting to enjoy trading equities again.
Last year's global stock market sell-off pushed equity hedge funds to a 7.1 per cent average loss, according to data group HFR, but this year they are bouncing back with a 9.5 per cent gain in the first six months of this year. Helped by widespread rallies in global stock markets, this marks their best first half of a calendar year in a decade.
Some funds are chalking up double-digit gains, such as Greenwich, Connecticut-based Lucerne Capital, which is up 32.8 per cent after a 21.9 per cent fall last year. The fund, which invests in Europe, has been helped by gains in various technology and industrial stocks, notably Dutch technology firm TKH Group, manufacturer Aalberts and chemicals company OCI.
John Armitage's Egerton Capital, which runs $20 billion in assets, has also made 17 per cent in its main fund this year.
However, despite this year's market rally, not everyone is in positive territory. Man Group's European Long-Short fund is down 1.2 per cent, while Crispin Odey's Odey European fund is off 2.8 per cent after last year's 53 per cent gain.
Lansdowne Partners, which manages around $20b, is having mixed fortunes, with its smaller Princay fund up 12.8 per cent and its European Long-Only fund up 14 per cent. Its flagship Developed Markets fund, meanwhile, has lost 4.8 per cent.
Figures from data group HFR nevertheless point to brighter times. The gap between the top and bottom decile of equity hedge fund performers has fallen to 37.5 percentage points this year, well down on the second half of last year when the sell-off caught some funds very much off-guard.
Of the range of factors affecting markets, most are proving helpful for hedge funds. Very cheap financing costs for companies and high valuations in fixed income, which are making bonds relatively unattractive for many investors, are strong tailwinds for stocks.
Quantitative easing is more of a challenge. Most commentators agree that the European Central Bank's €2.6tn bond-buying programme has pushed up stock prices. Its impending removal at the end of last year was seen by some as a factor in stocks' sharp sell-off in the fourth quarter, although investors have taken heart from the loud dovish noises coming from the ECB and the Federal Reserve this year.
However, QE can also be a major problem for hedge funds. Stockpickers have found markets driven by quantitative easing hard to navigate, as investors push both higher-quality and lower-quality stocks higher, making it harder to pick winners and losers.
Nevertheless, this interim period, between the end of new bond-buying and expected fresh ECB QE, is proving a happier hunting ground.
"We believe that certain European mid-caps are more inefficiently priced now than we have ever seen in the past 15 years," wrote Lucerne managers Pieter Taselaar and Thijs Hovers in a recent letter to investors.
Lansdowne recently told investors it has been buying UK mid-cap stocks. "Investor distress" is creating substantial mispricings in such stocks, it says, while the boom in takeovers is helping correct some of these mispricings, as corporate and private equity buyers look to snap up bargains.
While they are benefiting from rising stocks, funds are also finding opportunities on the short side — bets on falling prices.
Take fashion retailer Asos, for instance. The stock, which has slumped from £76 in March last year to £26.10, has for much of the past year proved a short-seller's dream, moving steadily lower in the second half of last year and over the past three months. A trio of profit warnings since just before Christmas, as the high street's woes have spread to the online sector, have helped short-sellers' cause.
Among those profiting is Lucerne, while Gladstone Capital Management, run by former Lansdowne analyst George Michelakis, which is up 11.4 per cent this year, has also been betting against the firm.
Overall, the amount of the company's stock out on loan — a good indicator of short positioning — is currently at 8 per cent, compared with less than 3 per cent last summer, according to IHS Markit.
Marshall Wace, meanwhile, took a short bet against German chemicals group BASF shortly before a profit warning, while it has been among a number of hedge funds benefiting from the long-running fall in Deutsche Bank's shares.
"It's a more fertile market. On the short side there's plenty to do," said a prime broker at one major bank.
Short selling has, for many funds, been a losing strategy for years and it is too early to say for sure that it is making a comeback. Many hedge fund managers have yet to prove that they can prosper when markets do anything other than rise. Nevertheless, hedge funds will be keen to make the most of a kinder environment for their trading strategies while it lasts.
Written by: Laurence Fletcher
© Financial Times