Stock markets across the globe were a remarkably tough nut to crack in 2018.
But this week there was news from some elite hedge funds that challenged this conventional wisdom…
And suggests they have unlocked the secret to making money in turbulent times.
Ray Dalio, founder of mega hedge fund Bridgewater, announced that his firm’s flagship Pure Alpha hedge fund notched a gain of 14.6% in 2018.
It was the fund’s best performance in five years.
Renaissance Technologies’, Two Sigma’s and D.E. Shaw’s flagship investment vehicles also recorded hefty gains in 2018.
The Renaissance Institutional Diversified Global Equities Fund gained 10.3%. Two Sigma’s Compass Fund rose 14%. D.E. Shaw’s Composite Fund gained 11.2%.
These returns seem nothing short of remarkable, particularly in a year when 93% of global assets ended in the red – the worst year ever.
These double-digit returns also trounced the performance of the average hedge fund.
According to Hedge Fund Research’s Global Hedge Fund Index, the average hedge fund was down 6.7% at the end of November. The final tally won’t be any better.
So what was Bridgewater’s secret?
As it turns out, it’s less a specific secret sauce than a different strategy.
You see, Bridgewater and the others are “global macro” funds.
Global macro funds bet on general economic trends that are uncorrelated to the movements of global stock markets.
A global macro fund can invest in commodities…
Profit from a drop in global stock markets…
And make billions from big bets on currencies.
Global macro is the style of investing that gave George Soros both fame and fortune.
There is, however, one big difference between Soros and today’s big players…
Soros would bet on a stock market or a currency based on whether his back aches.
In contrast, Bridgewater and the other top performers of 2018 are all quantitative funds driven by computer algorithms.
All this makes global macro investing a complex game far beyond the abilities of the average investor.
Still, you can’t help but wonder what Bridgewater and other global macro funds invested in.
The truth is… we’ll never find out.
That’s ironic. On the one hand, Dalio espouses a policy of “radical transparency” in running Bridgewater.
On the other hand, Bridgewater’s investment process is famously opaque.
So here’s my best guess…
Bridgewater’s biggest returns likely came from bets against the stock markets.
Bridgewater reportedly had a big short on European stocks. And a bet against any stock market would have certainly boosted returns during the fourth quarter market sell-off.
Given this kind of performance, you might expect Dalio (and his computers) to have unlocked the secret of the markets.
Well, not quite.
In 2017, Dalio’s Pure Alpha fund returned only 1.2%. That same year, the S&P 500 returned a whopping 21.7%.
Average the returns of 2017 and 2018 together, and you find that Dalio’s fund averaged a gain of only 7.9%.
That trails not only the S&P 500’s average return of 8.6%…
But also the return of Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B), which averaged an impressive 12.3% over the past two years.
The bottom line?
Not all strategies work all the time – no matter how much computing power is behind them.
Global macro funds’ ability to bet against markets happens to fare best when most investors are suffering.
For the record, Dalio expects global financial markets to remain rocky in 2019 despite the general health of both the economy and corporate profits.
As I have written, I expect the opposite to happen.
I am a big believer in market sentiment – a factor Dalio and his computer algorithms ignore.
Market sentiment has gotten so bad that I expect the U.S. stock market to trade back up to record levels by the end of 2019.
Dalio and the global macro crowd’s strategy of betting against global stocks is enjoying its moment in the investment sun…
And their views may even prevail over the longer run.
But I’m betting 2019 is not going to be their year.
Good investing,
Nicholas