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A Bright Idea for Hedge Fund Managers: Do Nothing

Managers complain that quantitative easing made many stocks move in the same direction

Hedge-fund managers’ reputations and pay depend on the quality of their trading ideas. Recently they haven’t looked so clever.

Hedge funds betting on stocks—a group running around $850 billion in assets globally—lost money for their investors in 2016, stripping out gains from simply tracking the market. This is the first year this has happened, according to a client memo from bank Morgan Stanley reviewed by The Wall Street Journal, since at least 2010, when the bank began tracking this data.

More simply, these hedge-fund managers would be better off doing nothing.

Early data for January shows these stock pickers still lagging the S&P 500 stock index, according to figures from Chicago-based date provider HFR.

Funds from John Burbank’s Passport Capital in San Francisco to Crispin Odey’s Odey Asset Management and Lansdowne Partners in London are among funds to have racked up big losses.

Picking rising and falling stocks, or long-short equity trading, is “a challenged strategy,” said Robert Duggan, partner at New York-based SkyBridge Capital, which invests in hedge funds and manages $12 billion in assets. “There are tremendous headwinds.”

Mr. Duggan, whose portfolio has been running very low exposure to long-short funds for most of the time since the end of the credit crisis, pointed to the growth of passive investing and index funds. Their influence in the market can mean moves in a stock price are now less linked to a company’s financial performance, he said.

The ability to generate so called ‘alpha’—industry jargon for the extra returns managers make over and above the market’s performance—is the most highly prized skill in fund management.

That is meant to command hedge funds’ high fees. And it supposedly distinguishes them from so-called ‘beta’—passively riding the market’s ups and downs. This is regarded as requiring little obvious skill and can be done far more cheaply.

Many funds have complained that trillions of dollars of quantitative easing by central banks has made many stocks move in the same direction, making it hard to pick winners from losers.

One of the biggest losers of recent months has been London-based Mr. Odey, founder of Odey Asset Management, which runs $7.5 billion. His European fund lost 49.5% last year, ranking it one of the world’s worst-performers, although it has made more than 4% this year.

In a call to his investors in January he pointed to market distortions caused by monetary policy, according to a person who listened to the call. These included the VIX index—the market’s so-called ‘fear gauge’—staying low despite a rise in political uncertainty.

“QE’s impact on expectations has meant there is very little of attractive value in the markets,” he said in an investor presentation, reviewed by The Journal.

Mr. Odey, whose fund has shrunk from around €1.1 billion ($1.19 billion) to €340 million in a year, is sticking to his guns, despite the poor returns. He continues to bet against energy firm Tullow Oil, which he has been negative since at least late 2015, due to concerns about the firm’s high debt level, he said on the investor call.

An Odey spokesman declined to comment.

Many hedge-fund managers have found themselves researching a stock but then having to guess the effect that politics and central bank policy would have on it, said Kenneth Heinz, president of HFR. Or else they “didn’t think enough about it and were victimized by wild swings in policy and uncertainty,” he said.

However, some see a brighter outlook for these funds.

Anthony Lawler, portfolio manager at GAM, which runs 119.1 billion Swiss francs ($119.61 billion), pointed to a rise in stock valuations over the past year and greater dispersion in the movements of individual stocks. These mean “you don’t want to be just long-only now,” he said.

U.S. President Donald “Trump will mean change,” said Christoph Englisch, portfolio manager at EnTrustPermal. “Change begets uncertainty, and that’s good for long-short equity managers.”

Hearing of the Committee on Economic and Monetary Affairs of the European Parliament

Introductory statement by Mario Draghi, President of the ECB, at the ECON committee of the European Parliament, Brussels, 6 February 2017

I am pleased to be speaking before your committee on the eve of the 25th anniversary of the signature of the Treaty on European Union in Maastricht. That bold decision marked “a new stage in the process of European integration”[1]. It laid the foundations for Economic and Monetary Union, and the European Central Bank. Ten years later, citizens started to have euro in their hands. This amounted to a considerable strengthening of the political commitment that has been keeping us together for 60 years.

It is easy to underestimate the strength of this commitment. But that would overlook the progress we have made. With the single currency, we have forged bonds that survived the worst economic crisis since the Second World War. This was in fact the original raison d’être of the European project: keeping us united in difficult times, when it is all too tempting to turn against our neighbours or seek national solutions.

But the objective of Economic and Monetary Union should be to strive to achieve “economic and social progress” as was the intention of the signatories to the Maastricht Treaty. And for this, we need sustained growth and job creation.

The resilient recovery we have witnessed in recent times has been a welcome step towards this objective. Over the last two years GDP per capita has increased by 3% in the euro area, which compares well with other major advanced economies. Economic sentiment is at its highest level in five years. Unemployment has fallen to 9.6%, its lowest level since May 2009. And the ratio of public debt to GDP is declining for the second consecutive year.

These are steps in the right direction. But these are just first steps. We need to continue on this path so that unemployment decreases further and more Europeans can benefit from the recovery.

I will start by discussing our contribution to supporting the recovery and will then lay out why the monetary policy decisions taken in December were the right ones in the current economic context. As you have requested, I will also discuss risks to financial stability, which we are constantly monitoring.

Supporting the recovery: the Governing Council’s decisions in December

Our monetary policy has been a key contributor to the positive economic developments I have described. Our measures have worked through the financial system and are benefiting the real economy at large by ensuring very favourable financing conditions.

At the December meeting, the Governing Council saw the need for the recovery to further mature and strengthen to ensure a sustained convergence of inflation rates towards levels below, but close to, 2% over the medium term. For this to happen, financing conditions have to remain supportive, taking remaining uncertainties inside and outside the euro area into account. We therefore decided to safeguard the amount of monetary easing for the period ahead.

Against this background, we decided to extend the asset purchase programme beyond March 2017, with the intention of conducting our purchases until the end of December 2017 or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. We will continue to purchase assets at a monthly pace of €80 billion until March. Starting from April, our net asset purchases will run at a monthly pace of €60 billion, and we will reinvest the securities purchased earlier under our programme, as they mature. This will add to our monthly net purchases.

Our December decisions strike a balance between our growing confidence that the euro area’s economic prospects are firming up, and – at the same time – the lack of a clear sign of sustained convergence of inflation rates towards the desired level.

On the one hand, the evidence suggests that the acute deflation risks have disappeared and that inflation is set to pick up over the coming years. And contrary to a widespread perception, euro area economic conditions have also been steadily improving. Euro area GDP growth has been solid in every quarter since the beginning of 2015, averaging 1.9 percent in annualised terms. Compared to 2013, there are 3.5 million fewer unemployed in the euro area, a decrease by more than 18%. And in the last quarter, the recovery has been broadening across sectors and across countries. Indeed, the dispersion of value added growth across euro area countries and sectors has declined sharply and stands close to its lowest level since the introduction of the euro.

But support from our monetary policy measures is still needed if inflation rates are to converge towards our objective with sufficient confidence and in a sustained manner. The pickup in headline inflation in December and in January largely reflects sizeable upward base effects and recent increases in energy prices. So far underlying inflation pressures remain very subdued and are expected to pick up only gradually as we go on. This lack of momentum in underlying inflation reflects largely weak domestic cost pressures. The still significant degree of labour market slack and weak productivity developments are weighing down on wage growth.

As I have argued before, our monetary policy strategy prescribes that we should not react to individual data points and short-lived increases in inflation. Our relevant policy horizon is the medium term. We therefore continue to look through changes in HICP inflation if we believe they do not durably affect the medium-term outlook for price stability.

Looking ahead, risks to the euro area outlook remain tilted to the downside and relate predominantly to global factors. Our current monetary policy stance foresees that, if the inflation outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council is prepared to increase the asset purchase programme in terms of size and/or duration.

Addressing financial risks in the euro area

You asked me to discuss the financial stability implications of our accommodative monetary policy. In short: the benefits of our policy clearly outweigh potential side effects. And the latter are best addressed – if necessary – through other policies.

As I have just argued, our monetary policy has been key in supporting the ongoing recovery. Going one step further: our measures have played a key role in preserving stability in the euro area – and that includes financial stability.

Let me now elaborate on the potential side effects of a very accommodative monetary policy on financial stability.

One of those side effects concerns the impact on banks’ profitability. Let us first look at the data. Following a slowdown in profit generation in the first quarter of 2016, the profitability of euro area banks stabilised in the second quarter. According to preliminary data, developments for the third quarter seem to be in line with those observed for the second quarter.

Monetary policy can have an impact on bank profitability through various channels. Our assessment is that so far these effects tend to largely offset each other. Low (and negative) rates might dent bank profits through the narrowing of net interest margins. At the same time, in supporting the recovery, accommodative monetary policy reduces delinquency and default. It thus improves the credit quality of firms and households. This improved credit quality in loan portfolios – together with increasing intermediation volumes – is certainly positive for banks. It has been a key factor sustaining banks’ earnings over the last year. Moreover, low longer-term interest rates increase the market value of financial assets held by banks. This, in turn, results in capital gains that further support bank profitability. This aggregate picture masks some heterogeneity within the banking sector. In particular, depending on their business models, individual banks might be affected in different ways by the low interest rate environment.

A second issue is the potential risk of credit or asset bubbles. Currently, we do not see compelling evidence at the euro area level of stretched asset valuations. Both corporate bond spreads and equity prices appear to be broadly in line with fundamentals.

Similarly, real estate price growth remains moderate in the area as a whole, although significant cross-country heterogeneity is observable. This assessment is corroborated by the fact that credit growth is still modest, which suggests that asset price developments are not accompanied by increasing leverage.

Nevertheless, the longer the accommodative measures need to be kept in place, the greater the risks of unwarranted side effects on the financial system become. For instance, asset prices may increase to levels that are not in line with fundamentals because investors might be tempted to take on more risk during times of low yields.

Such developments are best addressed by enacting appropriate macro and micro prudential policies.

While our single monetary policy is geared towards delivering price stability for the euro area as a whole, macroprudential policy measures can be designed to address financial stability risks that may be building up in specific market segments, jurisdictions or individual countries. Addressing potential risks at their origin also reduces the probability of contagion throughout the euro area.

Microprudential policies also help to reduce vulnerabilities in banks. I therefore welcome the European Commission’s risk reduction proposals presented last November, which further develop the EU’s legal framework for credit institutions and should increase the resilience of banks.

Conclusion

Let me conclude.

As I argued last week in Ljubljana, and as the crisis has shown, the benefits of the single currency can only be fully reaped if we have policies and institutions at national and European level that ensure it works for everyone.

In the run-up to the launch of the euro, there was a strong commitment to advancing along the path of institutional and economic convergence. The crisis showed that this commitment cannot be relaxed. In fact, it remains fully relevant today as we seek to strengthen EMU and the EU in the face of current uncertainties and in preparation for future challenges.

The euro area’s resilience in 2016 despite a range of negative shocks shows that we are on the right track. It also suggests that reforms at national and European level are paying off in terms of economic growth.

As the economic situation improves, and even though challenges in other policy realms have understandably been the recent focus of our attention, we should not stop our efforts to make EMU more resilient and prosperous. We can and should address the remaining, well-identified fragilities at national and European level. On the latter point, I look forward to the continued support of the European Parliament in the second half of this legislative term.

Thank you for your attention. I am now at your disposal for questions.

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Tiger Hedge Funds Become Wall Street Prey

Funds managed by disciples of Julian Robertson have fallen on hard times

Famed stock picker Julian Robertson and his protégés have ruled the Wall Street jungle for decades. After a down 2016, their reign is being challenged.

For the year, hedge-fund losses at Tiger Global Management LLC were roughly $900 million from a 15.3% loss. Lee Ainslie’s $11 billion Maverick Capital Ltd. was down more than 10% in its flagship fund. Andreas Halvorsen’s $30 billion Viking Global Investors LP and Stephen Mandel Jr.’s Lone Pine Capital LLC were down 4% and 2% respectively in their main funds, while Coatue Management LLC was up 2%.

That compares with a 12% gain for the S&P 500, including dividends.

“We are very disappointed by these results, which fall well short of our aspirations on both an absolute and a relative basis,” Viking wrote in its year-end investor letter dated Jan. 17.

These “Tiger Cubs,” a generation of hedge-fund firms founded by traders who once worked for Mr. Robertson at his Tiger Management, are among the wave of stock hedge funds that posted losses for 2016. The MSCI AC World index gained 8.5% for last year excluding December, but equities hedge funds captured just 20% of that return, according to Morgan Stanley.

That relative return was the second worst since the 2008 financial crisis.

“Bottom-up” stock pickers like the Tiger Cubs were among the hardest hit. These types of managers make their investment decisions by talking to management teams and poring over corporate filings, among other research.

This tactic contrasts with other equities hedge funds that will tactically get into or out of a sector based on a broader view of how an industry will be changed by events like changing regulations or a slowdown in China.

But last year’s markets were difficult for Tiger Cubs and other bottom-up investors because companies often didn’t rise or fall on their individual fundamentals. Instead, entire sectors of the market traded in lockstep, such as when energy companies rallied during the first half and when financial stocks surged after the presidential election of Donald Trump on expectations of economic growth. Stocks that traditionally were more expensive and had strong growth prospects also sold off, another development that surprised some of these managers. Those stocks had driven funds’ gains last year.

Some traders say forces like algorithmic trading and passive investing appeared to drive the market moves. Both have become larger parts of the market in recent years.

Traditional “quants” program their computers to bet on statistical relationships among securities prices. At the same time, passive investments such as exchange-traded funds can cause stocks in a sector to move together, regardless of their underlying characteristics.

That lockstep movement can help funds that invest based on a broader view of the world or political changes but challenges investors whose playbook relies on closely examining a firm’s balance sheet.

“It’s too early to say that fundamental stock picking is dead; it’s hard to envision a world with only robots and passive investors,” said Greg Dowling of Cincinnati-based Fund Evaluation Group, which advises on roughly $60 billion of client money. But “opportunities may be more episodic.”

Mr. Robertson, who declined to comment through a spokesman, started Tiger in 1980, and the firm went on to become one of the most successful private investment funds in the world, managing more than $22 billion at its peak. He still claims among the best long-term track records in the investment world, at about 25% a year.

The firm returned client money in 2000 after losses and investor defections.

Tiger has since reinvented itself into a business that backs smaller hedge funds, while Mr. Robertson’s former employees collectively manage more than $100 billion in some of the industry’s biggest funds. They frequently show up in the same trades, a result some of them ascribe to their shared investment philosophy.

In 2016, funds like Charles “Chase” Coleman’s Tiger Global lost money when previously highflying tech stocks declined.

The first six weeks of last year, Amazon.com Inc. and Netflix Inc. dropped 25% and 24% respectively, compared with a 8.5% decline for the S&P 500. Morgan Stanley said a quarter of stock hedge funds by mid-February were down 10% or more.

Tiger Global’s technology-focused hedge fund was down 22% after the first six weeks of the year and ended the year down 15.3%, said people familiar with the firm.

Positions that hurt Tiger Global in the first quarter included Amazon.com, JD.com Inc. and Netflix. The fund had sold out of Netflix, one of its biggest positions, by the end of September and is now running with less concentrated positions, people familiar with the firm said.

Losing health-care bets also hurt Tiger Cubs, with a wager on Valeant Pharmaceuticals International Inc. stinging Lone Pine and Viking. Viking’s other biggest losers for the year included Allergan PLC and Teva Pharmaceutical Industries Ltd., according to its letter.

Since the election, some traders have predicted the environment for stock picking would improve. Mr. Trump’s plan for deficit spending, tough talk on trade and taxes and lighter regulation for banks, pharmaceutical companies and other industries have meant increased volatility. They say that volatility, plus the waning of central banks’ global bond-buying programs, could break the quiet markets traders have complained about in recent years.

Coatue, Maverick, Tiger Global and Viking gained in January, said people familiar with the firms, with Tiger Global up 5.5%

Regardless, some of the Cubs are making changes.

Mr. Mandel of Lone Pine has become much more focused on whether the positions that the $28 billion firm holds are included in the holdings of ETFs, said people familiar with the firm. Lone Pine began collecting data on these issues more systematically last year, one of the people said.

Investors redeemed 10% of their money from Lone Pine last year, a higher percentage than in past years, the people said.

Viking hired from Goldman Sachs Group Inc.Samer Takriti, “an experienced risk quant and Ph.D.,” to help the firm increase its awareness of forces that can affect its portfolio, Viking said in its year-end letter.

Meanwhile, Maverick, which rolled out a quant effort in 2006 to inform its investment process, is doubling down on losing bets from last year.

“The large majority of investments that were costly will prove to be mistakes of timing rather than judgment,” Mr. Ainslie wrote in his year-end letter dated Jan. 17.