Wednesday, August 29, 2007

The Good, the Bad & the Ugly

Equity Market Neutral funds come in a variety of flavours and strategic pursuits. Some are dsciplined, other nebulous by design. But like footprints in the snow, one cannot hide from the trail left by one's returns. This could be good or bad, depending upon whether the results in fact, corroborate one's pursuit, or unveil it's charlatan roots for all to see. The past month's events provides a fascinating peep into this world, with a guided tour by yours-truly.

First is the BMNIX, the Rosenberg Laudus small-cap value fund that plunged so spectacularly and sympathetically with Tyhke, GS, AQR, and Renaissance. BMNIX is unabashedly skewed towards the smaller-cap and the value on the long side, presumably versus things with less value on the short side. Rosenberg has always had a healthy respect for momentum, so, potentially, their pari-passu was NOT on the short-side, but on the long. Interestingly, they meaningfully recouped most of the extreme dislocation drop, probably as a result of higher turnover, and the fact that value-oriented pari-passu small-cap were as illiquid on the up-bounce as they were on the puke. Bravo!

Next we have the approx $2bn JP Morgan Market Neutral Fund. Yeeeehaw! OK so he's recovered most (down only 2% mtd), but an 11% unleveraged peak-to-trough drawdown with probably 400 to 500 names per side. Ooooooch! I cannot infer what exposures caused that, but my guess is he must have had excess resource and value exposure on the long side coupled with the pari-passu short portfolio that WENT-UP when the market was going south.

Another dubious horse from the same JPM stable is the Highbridge US Market Neutral Fund. Though apparently different managers, and different holdings (this one is seemingly more concentrated and less diverse) it too suffered what was a 10% unleveraged drawdown. And again while nothing jumps out on the long side, without detailed analysis, one might assume that it was the ill-behaved short-portfolio that was the culprit. Maybe it was THEIR fault, for Highbridge admitted deleveraging, and the pari-passu would of course have hit their sister-short portfolios. The de-risking also perhaps accounts for why they only recovered less than half their loss, for if they cut (even some), they would have locked in losses at distressed levels indeed.

The next rung down on the ladder, we have TFS MArket Neutral Fund, who got slammed on the order of 13.5% peak-to-trough unleveraged. Ouch! Perusing his holdings, the only thing I can say is that his 150 or so long portfolio positions resembles everyone else (and the market) less than perhaps any other manager. They are certainly NOT "value" (portfolio PE of 65x), and are skewed to the tech and growth areas so their yearning for "Capital Appreciation" must be founded upon hope and prayer. Judging from performance, this market neutral iconoclasm should not be worn as a badge of courage. The horrid time must have been exacerbated by high pari-passu on the short side.

Near the bottom, we have the Robeco Boston Partners Market Neutral Fund. I found this interesting because they've historically done a nice job of unearthing attractive value+growth on the long side that encouraged Robeco to "buy the firm". They are more fundamental than their brethren, but that apparently doesn't guarantee success. I would suggest their approach is more an over/under valuation relative to more sophisticated sector/market/stock-level valuation, for their returns regress upon this factor rather highly. And notably, the level of relative over/under valuation has indeed been a poorer predictor of returns since mid-Q2 than most other simple value or price-reversion factors. But -12% from their highs and nearly -5% ytd, one must ask why these valuation tails are not more effective. The answer probably lies in the misfourtune of the over-shorted short side which should (and will) go down and underperform, but probably not until existing shorts puke more and unwind positions diminishing short-interest to levels where actually selling will take the price down.

Finally, at the bottom, we have a fund hilariously called "THE GERONIMO FUND", who in sympathy with its moniker, has also taken a grand leap into the abyss. In attempting to mimic HFR index hedge fund performance, the managers Mssrs. Prokupek & Krause, have managed to flame-out spectacularly, thereby insuring a return to higher education or a career change into Colorado's hospitality industry.


Macro Man said...

Very interesting indeed. The currency chaps aren't having a particularly good time of it, either. FXSTUNIU (Index) provides you with a pretty reasonable proxy for the FX trading success of 'the streeet.'

Oh, and the Geronimo Fund is, indeed, aptly named. Highly amusing.

Charles Butler said...

Please clarify something, madam...

Clearly, some of these entities managed to bounce back to something approaching an acceptable degree. Is the assumption here that they just continued to let the machine do its thing, counting on reversion - or believing that the event was a sygma-whatever? Or, if it was caused by de-leveraging, does it mean that they will continue to let the machine run, but with less borrowed money and probably really pissy returns? Also what happens to backtesting results now that this 'outlier' is in the database? And do you expect to see even the saved of these market neutrals even existing six months from now?

"Cassandra" said...

There are lots of amusement-park rides i Quantland: divergent and convergent; momentum or counter-trend, growth or value, all with different time frames; twists, intentional tilts and/or filters.

The diversified portfolio is probably close to breaking even (dragged down by value and certain momentum sub-components), PROVIDED you didn't puke, reduce leverage, or change your tune. Those employing sound strategies not uber-leveraged (irrespective of the market-to-market swoons) that hung in there will do just fine, emerging a little smarter as to the probable correlation between credit risk and (if you will) similar-position liquidation risk. Some who were fortunate and not running a full portfolio of strategies and that cherry-picked "the soundest" in the correct quantities, probably will emerge july & August up sufficiently to offset your risk. If your managers are NOT doing that, then write me and we should talk. Just because you get some bad gasoline, doesn;t mean you should throw away the car. Most strategies in quantland (I think, or at least talking my book) are soundly based, and, on balance more convergent than divergent. After a hurricane is often the best time to write prop-cat insurance since rates are "hard". Quantland is, on balance, not much different.

As for back-testing impacts, I would suggest that anyone having seen and met God during those two weeks culminating that fateful Thursday and got The Religion, one will be better equipped for anything subsequent. Also, you;d be a fool NOT to de-emphasise the bubble (for example) in any backtest. I would have heartily prefer the more-soundly based strategy that drew down in late 1999 & early 2000. Future backtests will reveal yield this datapoint, but I heartily expect it to be followed by a diffusion period yielding better returns. This will only reinforce the validity of models - not detract from them.

So in Equity Quantland, there are sound excuses and mitigating circumstances. Now in the dungeon below, in Mortgage-Dept, where the Kool-Aid is mixed and the Cabalists inhabit.....

Anonymous said...


What are your current thoughts about the TFS Market Neutral fund?