Mind the Gap – Q3 Hedge Fund Performance Review

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This third quarter update of Global Investment Report’s 18th annual global hedge fund survey highlights some of the remarkable distortions revealed across markets, while reporting on the current sentiment of leading investors and tracking how the top 50 funds have performed through the first three quarters of 2021.

A Dickensian sounding article in The New York Times caught my attention. Written by the paper’s senior economics correspondent Neil Irwin, it started off saying, “Americans are, by many measures, in a better financial position than they have been in many years. They also believe the economy is in terrible shape.”

This got me thinking of other paradoxes.

The flagship gap – triggered by consumer and corporate demand colliding with clogged supply chains – sits off southern California’s ports with dozens of massive, fully loaded container ships waiting to dock.

Then there’s the great macro divide: many economists and asset managers see inflation, which in October hit an annual rate of 6.2% (the highest since 1990), as more than a response to economies reopening. They are increasingly fearful of how far the Federal Reserve may be falling behind the inflation curve. Fed Chair Jerome Powell finally announced a start to tapering the bank’s $120 billion monthly bond purchases. But as of mid-November, Powell was against directly raising rates, believing this will not address the underlying issues driving inflation, despite overnight rates remaining at crisis-level lows.

The Fed’s fear of letting the bond market adjust to a vastly improved economy since Covid struck nearly two years ago has created sharp imbalances reflected most clearly in negative real returns across the yield curve. Fearful of the recovery’s fragility, European and Japanese monetary policies remain even more accommodating. And the Bank of England just spooked bond markets on both sides of the Atlantic when it suddenly yanked back on a proposed rate hike (see graph below).

Ultra-low rates continue to fuel capital flows into higher risk assets, keeping the junk bond rally going. According to ICE Data Services, soaring issuances has pushed the high-yield debt market above the $1.5 trillion mark for the first time. The Financial Times reported a record 149 companies have tapped into the junk bond market so far this year, including the likes of the cryptocurrency exchange Coinbase and gaming platform Roblox, the latter paying less than 4% for $1 billion (see table below). The gap between risk and return on sub-investment grade debt has rarely been so wide, pushing bond prices even higher while major equity markets continue to rally, even after the S&P 500 has doubled since March 2020.

Then there’s the polar divide between the world’s two largest markets. Through September, US stocks gained more than 15%, according to MSCI. China was down more than -16% in Yuan terms as local authorities pursue actions that have chilled investor sentiment. And this performance gap drastically widened by early November as US stock returns surged to nearly 26% for the year while Sino shares have remained unchanged.

Despite a broad sense Covid-19 is finally coming under control, we're seeing disturbing infection spikes among the large percent of the unvaccinated as the weather turns cold, leading to lockdowns. That indicates we'll likely see another wave of the pandemic hit developed nations this winter.