Third Quarter 2018 Review of the Long/Short Equity Hedge Fund Space

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By Kevin Hurd and Steve Togher for Cross Shore Capital Management

US equity markets had a very strong third quarter with the S&P 500 Total Return Index gaining 7.7% and now up 10.6% year-to-date. US markets were buoyed by a continuation of strong economic trends, including unemployment levels reaching near-record lows. Growth stocks continued to outperform value with the S&P 500 Growth Index up 9.3% for the quarter and up 17.2% for the year. Conversely, the S&P 500 Value Index was up 5.9% for the quarter and is only up 3.8% year-to-date.

Long/short equity hedge fund returns varied widely for the quarter, depending on portfolio directionality, sector exposure, and geographic exposure which resulted in a modest average return of 0.5%[i]. Strategies focusing on the healthcare and technology sectors continued to outperform, returning 4.9%[ii] and 2.3%[iii] respectively for the quarter. In the healthcare several significant transactions including Cigna/Express Scripts, CVS/Aetna and Takeda/Shire were pivotal in the sector’s performance.  In technology we noted a significant shift into U.S. centric software companies (Saas/Cloud) and a reduction in semiconductors and China-tech names.   Not surprisingly, short exposure tended to be a detraction to performance in strong equity market for the quarter, as businesses that are over-earning today are extrapolated to outperform in the future.  This will correct as companies are forced to lower guidance.

Growth-biased strategies disappointed for the second quarter in a row, losing 1.6%[iv] on average during Q3 and now down 2.3%iv for the year. Energy and materials sectors strategies also disappointed on average, losing 0.1%[v]. Managers with significant exposure to non-US stocks also struggled on average during the quarter which is not surprising given the MSCI Europe Index returned a modest 0.4% and the MSCI Emerging Markets Index continued its slide, down 2% in Q3 and down 9.3% year-to-date. Europe continued to show uneven and low economic growth and emerging market economies have continued to struggle as well.

Financial market risk increased in September as concerns over rising interest rates, trade tariffs, and weakness in non-US economies continued to make headlines. We noted banks involved in commercial lending tending to come under pressure during the quarter. We also saw losses in real estate sector funds as both REIT and homebuilders were down for the quarter.

The result was mixed returns among long/short equity hedge funds for the month and a general shift towards more defensive portfolio positioning. These risks accelerated into October causing substantial near-term market volatility. The dislocations created by this volatility could result in significant opportunities for skilled managers. Cross Shore continues to believe that a hedged strategy is the best way to materially participate in rising equity markets while providing downside protection.

[i] HFRI Equity Hedge (Total) Index

[ii] HFRI EH: Sector – Healthcare Index

[iii] HFRI EH: Sector – Technology Index

[iv] HFRI EH: Fundamental Growth Index

[v] HFRI EH: Sector – Energy/Basic Materials

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Economy , Financial Advisor Center , Hedge Funds

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