Strategies
Confusion about—even avoidance of—hedge funds is in large part due to the industry’s perception as an impenetrable monolith. To help unravel the mystery, we’ve published stories over the past several years that explain the industry’s distinct strategies, which can give investors unique, understandable and flexible exposure they can’t find elsewhere.
• Distressed investing targets opportunities when companies are in trouble but are likely to recover, and managers arbitrage bad news that’s priced into securities.
• Event-driven strategies are among the most consistent in performance because they respond to short-term triggers that tend to have more predictable outcomes.
• Fixed-income arbitrage is one of the most challenging strategies, targeting comparable securities whose values have diverged but are expected to realign.
• Equity long/short is the most popular stock strategy; it’s designed to outperform during down markets, but is likely to underperform during bull markets.
• Global macro targets broad economic and market metrics, from interest rates and foreign exchange to commodities to stock and bond indices. Managers profit from riding protracted moves and struggle when markets are trendless.
Funds
Since its launch in April 2006, MOAB Partners has been a steadily performing event-driven fund with annualized returns of nearly 9% and volatility of just 7%. A key to its consistent performance is its ability to excel during down markets: It’s outperformed the market 44 of the 45 months when the S&P lost money.
Whether it involves senior unsecured debt, distressed credit or equities, this contrarian performance has been achieved because the fund avoids crowded trades, explains manager Michael Rothenberg. MOAB seeks exposure to quality, underfollowed small companies that are flying below most radar screens and selling at attractive values. The portfolio’s blend of arbitrage and credit positions generates consistent yield, which helps dampen volatility. And Rothenberg is efficient in regularly redirecting capital to the most attractive opportunities.
Just as important, the fund, with $529 million in assets, limits drawdowns (the worst being 17% during the financial crisis, which it made up in four months). It does this by sizing positions inversely to their potential downside. This means the manager can miss the mark on a number of bets but still end up netting attractive gains.
The Napier Park European Credit Opportunities Fund was a “Volcker baby,” a forced spinoff out of Citibank when the ex-Federal Reserve chairman Paul Volcker required banks to get out of hedge funds.
Since its launch in September 2010, the London-based fund has generated annualized returns close to 18% with relatively low volatility of just 8.25% and a worst drawdown of 15.31%.
The $653 million fund, part of the $8.4 billion alternative asset manager Napier Park Global Capital, has delivered these returns by investing in European corporate credit, specifically high-yield bonds, leveraged loans and structured credit. While this sounds risky, Michael Micko, the managing director and head of European credit strategies, explains that his team is able to exploit misperceptions and confusion about the European credit market, which is far more inefficient and fragmented than the U.S. debt market.
“Our extensive bottom-up research gives us an edge in better assessing risk than the broad market and many rating agencies,” explains Micko. “This not only enables us to move aggressively into dislocations, but reduces potential downside of non-investment-grade exposure.”
The fund also mitigates risk by hedging overall macro conditions. If managers have misjudged negative sentiment, these shorts can limit the fallout. Collecting substantial yields on its credit exposure on core investments can do the same.
The Hildene Opportunities Fund II, co-managed by Brett Jefferson and Dushyant Mehra, also shops the high-yield market. But the Stamford, Conn.-based fund is far more domestically focused on credits of regional and community banks and financials, corporate debt, real estate and consumer and mortgage debt. Like Napier’s, its book has extensive exposure to structured credits because that’s where it’s able to identify value. “Their complexity can give an edge to investors who can drill down and truly distinguish risk and opportunity,” explains Mehra. This is especially true for smaller segments of structured credits, which larger firms, the ones that do the most research in the space, avoid because there’s insufficient liquidity to meet their needs.
Though Hildene’s history dates back a decade, this fund is one of the youngest on our list, having launched in August 2011. Still, during its first six years, the fund has racked up annualized gains of nearly 16%. Its standard deviation was a very low 5.03%, and its worst drawdown was 5.6%. The fund’s management has achieved these remarkable numbers by staying small, being quick to adjust duration when structured credit markets change, by applying hedges and by seeking high current yield as ballast.
It’s also compelling that the $602 million fund has periodically closed to new investors and has returned over $150 million in capital to investors when there haven’t been sufficient opportunities.
Another unique feature: Half the fund’s performance fees are not paid to the manager until investors redeem. This rare structure prevents investors from paying for a substantial part of performance that could be lost if the fund was to subsequently struggle.
NOTE: We are not recommending any fund. Past performance guides but does not predict. You need to do your own homework. For help, please see our article “No Short Cuts” on hedge fund due diligence in the November 2013 issue of Financial Advisor magazine.