By Nicolas A. Tuteleers, BSc International Business Administration at Rotterdam School of Management, Erasmus University
With the recent decline in equity prices worldwide, many investors had to sustain significant drawdowns in their portfolios since the beginning of the year. This includes many hedge funds and other institutional investors, who found themselves overexposed to the most poorly performing sectors following last year’s rally, namely consumer cyclical, technology and communication services (all down more than 20% year-to-date in the United States). Some of the largest funds in the industry have even come under media attention after incurring particularly large losses, despite multiple warnings of impending market volatility. Whether this trend will continue into the second half of this year will largely depend on investors’ response to the quantitative tightening programme launched by the Federal Reserve, which is likely to send yields higher and spread fear of an incoming recession.
Growth Investors in Pain, Tiger Global
Following the global sell-off initiated at the beginning of the year, Tiger Global Management’s flagship fund, managed by Chase Coleman, had reportedly lost 52% of its portfolio value since the beginning of 2022 (costing investors almost $24.0Bn over a $45.9Bn ending value in 2021). However, Tiger’s long-only fund fared even worse with a 61.7% fall by the end of May. This prompted a 50bps cut in its management fee until December 2023. When combined with the losses suffered late last year (standing at roughly 7%), the fund has effectively managed to wipe out more than two-thirds of its gains since its inception in 2001, according to an estimate made by LCH Investments. This comes as no surprise given Coleman’s aggressive investment style, oriented towards technology and growth stocks in general. Indeed, according to his fund’s latest 13-F filing(effective 31st March), some of his most prominent holdings still include Nu (7.4% of the portfolio, down more than 50% from the reported acquisition price), Snowflake (5.9%, down 45%), Doordash (3.6%, down almost 40%) and Coinbase (0.6%, down more than 60%). In the first quarter, the fund was also forced to sell off a large amount of its more speculative positions, including: Amazon (2.5% of the portfolio), Uber (2.3%), Zoom (2.3%), Netflix (1.4%), Spotify (1.2%) and Robinhood(0.6%). It will be interesting to follow how the fund’s management will reposition the portfolio to recuperate some of these losses. Especially considering that it has having now underperformed its Nasdaq 100 benchmark by 56% since the start of 2021 . Undeniably, current market conditions call for an overhaul of the fund’s strategy to minimise downside risk for investors. Having said that, history has taught us that managers can be stubborn (especially in tech, take Cathie Wood as a prime example), and that whether growth stocks will continue to underperform is now a matter of investor sentiment in the face of upcoming macroeconomic developments.
In the meantime, Tiger has reportedly “parted ways” with Partner Sam Harland, who was responsible for a massive stake in used-car dealership company Carvana. The fund had progressively acquired over $1.0Bn of the company’s stock since the beginning of 2019, which is now down nearly 80% from the average historical acquisition cost. Harland also paved the way for several bets in private ventures, including Bravado (a professional networking service), Instant Teams (a remote talent marketplace), and WizeHire (a hiring platform), al l through Tiger’s Global Venture Capital arm. Indeed, echoing efforts by other large institutional players such as SoftBank, Tiger has been ramping its private markets exposure in recent years. As exuberant returns and soaring inflation made exposure to other asset classes more attractive, wealthy retail investors were quick to seek diversification in private markets, generating strong demand for Tiger’s funds. One in particular, an $11Bn vehicle known as PIP 15, raised $1.9Bn from J.P. Morgan’s wealth management clients. Though impossible to quantify, the runaway selloffs experienced by most unprofitable tech stocks in the first half of the year likely reflect the performance of the fund’s private holdings.
The Netflix Debacle, Pershing Square
Another hedge fund which particularly suffered from the losses incurred in the tech space is Pershing Square, managed by legendary investor Bill Ackman. Contrary to Tiger’s strategy, Ackman is known to take a more balanced and opportunistic view on investing. When Netflix (NFLX) tumbled more than 20% in the after-hours of January 20th (following its Q4 ‘21 earnings announcement), the fund took on a $1.2Bn stake in the company, using the $1.25Bn in proceeds from the sale of its interest rate swaptions acquired in December 2020 (generating $1.1Bn in profit). According to the fund’s annual shareholders’ presentation, the investment thesis behind Ackman’s Netflix bet relied on 5 major drivers: the growth potential associated with its subscription-based model, its strong competitive position, the pricing power derived from its superior value proposition, the expected profit margin improvement attributable to economies of scale, and its world-class management team.
The fund seemed to bet on a market overreaction to the company’s lower-than-expected short-term guidance on margins and future subscriber growth for Q1 ‘22, laid out in its 8-K filing. In fact, Pershing Square’s annual letter seems to highlight the strength of Netflix’s business model, outlining medium- to long-term bullish expectations linked to the company’s operating leverage (i.e. marginal revenue increases should result in greater-than-proportional earnings growth). On April 19th, Ackman’s expectations were proven wrong, and Netflix issued a second round of alarming guidances for Q2 ’22 combined with poor results for Q1 (losing 200,000 paid subscribers in the period). The next day, the fund liquidated its entire stake in the company, at a ~40% discount to the reported acquisition price (losing investors $470M, setting the portfolio back 4% on its YTD performance). In a letter issued by Bill Ackman himself, Pershing Square admitted to having overlooked the risk associated with the company’s high operating leverage. It also highlighted the high degree of predictability required by its densely concentrated portfolio, something which an investment in Netflix could not guarantee over the coming months. As of its latest 13-F filing, the fund still maintains substantial holdings in companies such as Lowe’s (LOW), Chipotle (CMG), Hilton (HLT), and Domino’s (DPZ), reflecting a fairly conservative investment strategy. Despite this, the fund is now down 25.3% year-to-date, trailing its S&P 500 benchmark by ~4.7%.
Good Risk Management is a Scarce Commodity, Melvin Capital
Though most funds managed to stay afloat through the bear market pressures, some were driven into liquidation. One of them, Melvin Capital, started to suffer large losses at the beginning of 2021 following the meme stock debacle . The fund had taken on a substantial short position against legacy videogame retailer Gamestop (GME), before a group of retail traders started buying the stock in masses (driving up the price 2,400% to $325). Melvin eventually incurred a 39% loss for the year, losing almost $5.0Bn in net asset value. Its troubles were not over just yet however, losing a further 23% in the first four months of 2022. After the fund’s manager, Gabe Plotkin, initially revealed a plan to discard the fund’s high-water mark provision, effectively allowing him to charge performance fees to his investors, Melvin was forced to backtrack. After an eight-year track record delivering an average return of 30% per annum until the start of 2021, building up his reputation as one of the best managers in the industry, Plotkin declared in his final address: “I have given everything I could, but more recently that has not been enough to deliver the returns you should expect. I now recognise that I need to step away from managing external capital”. The fund is expected to return nearly all of its $7.8Bn under management by the end of July. However, Melvin is not the only sizeable hedge fund to have shut down in recent months. Archegos Capital for example, famously made headlines in early 2021 after being forced to liquidate over $30Bn in equities, including major stakes in Discovery (formerly DISCA) and ViacomCBS (formerly VIAC) which caused their share prices to tank. Major banks such as Crédit Suisse and Nomura, supplied massive credit facilities with fairly lacklustre due diligence to help Archegos lever its positions, resulting in billions being written off from their balance sheets upon the fund’s liquidation.
Looking Ahead
The markets seem puzzled on the economic outlook for the rest of the year. In recent weeks, American indices sharply recovered from their bear market lows, with the S&P 500 gaining more than 12%. Having said that , many market commentators prescribe caution. In an interview with Andy Serwer, Mohamed El-Erian (Chief Economic Adviser at Allianz) noted: “We are not yet entering a recession. Is the risk of a recession high? Yes, it is high and getting higher.” He points regulators to three points of action that will be key determinants of economic growth going forward: controlling inflation by having central banks tighten monetary policy and regain credibility, protecting the most economically vulnerable in our society through comprehensive fiscal reforms, and ensuring financial stability by reducing the amount of risk incurred by non-financial firms (driven by years of low or zero interest rate policy). These diverging views are also reflected amongst investors. Whilst the unshakeable optimists like Warren Buffett (Berkshire Hathaway) argue that there is never a bad time to enter the markets, sceptics like Michael Burry (Scion Capital), Ray Dalio (Bridgewater Associates) and Jamie Dimon (J.P. Morgan) paint a much gloomier picture for Western equity markets going forward.
Since the beginning of the year, global macro and managed futures strategies seem to have outperformed other hedge funds, leveraging the uncertain economic environment to find mispricings in the market and profiting from surging commodities. Funds oriented towards aggressive growth strategies have largely sunk in value, proving once again that value tends to be preferable over the long run. How long we may expect this to last will largely depend on how responsive Western governments and central banks will be in addressing this ongoing uncertainty, and how the war in Ukraine will eventually unfold.
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