Tuesday, August 19, 2008

Petroleum Jelly

If you happen to be in need of Vaseline and find that your local pharmacy is sold out, never fear. Chances are, the entire stock has been purchased by your friendly neighbourhood hedge fund manager. If you ask nicely, perhaps he'll let you borrow a tub or two.

One of the signal trends of the past month or so has been the sharp decline in the oil price. Part of this is likely attributable to the China/global growth slowdown theme that Macro Man has highlighted recently, and part of it is likely a result of some sort of dollar strength feedback loop, which itself is at least partially attributable to a softening of the ECB's rhetoric.

On the face of it, it would appear that the hedge fund world has dodged a bullet in oil. After all, the CFTC data has shown net speculative positioning to be fairly light over the past month or two, and even slightly negative for the last few weeks.
Sadly, that chart doesn't tell the whole story. It would appear that a number of people decided to play the energy patch through the equity space rather than the physical/futures. Shortly before disappearing on holiday, Macro Man observed that the performance of "market neutral" equity hedge funds had been submarined by an apparent addiction to "equity market crack": long energy and short financials.

What he didn't realize at the time is that many of his macro brethren appear to have become ensnared in the same addiction. The chart below shows the "equity crack" trade in red, and the HFR Global Macro NAV index in white. Ouch!

To put recent hedge fund performance in perspective, Macro Man had a look at the monthly returns of the Credit Suisse/Tremont hedge fund index, a broad measure of more than 5000 funds that has tracked hedge fund performance since 1994.

It turns out that last month was the worst month for hedge funds since April 2000, which was the month that the dot-com bubble started to go badly, badly wrong.
Ouch! This perhaps provides some explanation for the recent dollar move; insofar as the hedge fund universe (and, it must be admitted, the real money universe as well) had a long commodity/short USD exposure that has gone seriously wrong recently, perhaps some of the relentless supply in EUR/USD has represented some sort of proxy hedging.

In any event, this dismal performance might explain the run on Vaseline at your local Boots or Duane Reade. If you want to borrow some, however, you'd best call it by its brand name. Any reference to "petroleum" jelly to your local hedge fund manager might get his front door slammed in your face.


Anonymous said...

Nice chart MM - the asymetric nature of the hedge fund performance vs the street value of your 'crack' when comparing the journey up to the one back down must make particularly poignant reading.

Scary how good your drugs analogy is. Coming down can be rough.........

Anonymous said...

Who is the winner this time, if hedge funds were wrong?

Macro Man said...

Sadly, it's not a zero-sum game. Just because hedge funds lost a bucket doesn't mean someone else made loads....unless, of course, you want to talk about the positive income shock to global energy consumers from lower oil prices.

Anonymous said...

To think that the USD's rally is short coveraling alone is too simple. The declines in the HF index you note has also prompted funds that have never hedged their international exposure to do so - in size. Private equity funds with a few hundred million AUM a few years ago now manage a few billion. As their AUM grew, their investment tentacles started stretching around the world. As the USD was declining, and their returns were north of 20 pct, FX hedging was reduced to a single line item on a long forgotten spread sheet. Now those same funds have flat to negative returns, and they're long illiquid and underperforming assets. The FX risk in their portfolios, and the hedging there of, is one way to batten down the investment hatches and reduce risk. Macro Man, while you were on the beach, I was explaining plain vanilla FX hedging to a number of portfolio managers who are looking at FX exposure of their underlying assets hard. It is this hedging activity that makes me continue to be a USD bull. The USD has rallied by default, not merit, but it will continue to do so as investors attempt to mitigate risk that never used to matter...

James said...

Ive heard of some prop firms disasters from the last month. Guys at chicago firms getting killed in this unwind.

Anonymous said...

The chart I checked doesn't seem to correspond with the comparison chart you provide.
I suppose the target is neutrality: long core positions - commodities and short financials for now)
Am I looking at the wrong chart?

Jens said...

MM is showing the HFR Macro Index, and the one you are referring to is the HFR EMN (Equity Market Neutral). Two very different strategies. Regardless, it was a very tough month for most HF strategies. Volatility is great for HF's as long as they are on the correct side of the moves. Those funds that are correct on the credit unwind are still making buckets of money.