Over the past two years, there’s been the market and then there’s been everything else. Republican election sweep ensures that the show will likely continue well into 2025. The market is on pace this year to nearly double its five-year annualized returns of 15.7 percent.
A benchmark of the 50 most consistently performing hedge funds (that’s recalibrated annually) is on track through September to match its historical annualized gains of 12.5 percent.
That may sound like a silver lining in comparing this group of hedge funds to the market. But it’s a lot more significant than that.
Sustainable hedge fund performance that’s minimally correlated to the market is a key goal of alternative investing, enabling the most skilled managers to outperform when the market stumbles.
Through the first three-quarters of 2024, the unexpected outlier in the Top 50 continues to be emerging markets. It was the best-performing strategy with one fund having beaten the returns of the S&P 500.
The hedge fund industry as a whole is riding the market’s coattails, suggesting even greater correlation with the S&P 500. And that’s potentially disconcerting because the average hedge fund was already highly correlated to the market.
Not so for the benchmark.
When there’s broad momentum-driven consensus about where the market is going, that’s usually a cautionary sign, according to stalwarts like Greenlight Capital’s David Einhorn and Warren Buffett. Are they right? Or will they miss the next leg of the rally?
The S&P 500 is poised to deliver two consecutive years of 20 percent-plus returns. That’s rarified space, supercharged by the Republicans’ sweeping victory.
The last time the S&P delivered multiyear 20 percent returns (since 1960) was right before the Tech Wreck (see chart below).
Source: Macrotrends
Alternative funds are not going to come close to matching these gains — they’re not designed to. Accordingly, the Top 50’s returns of 9.2 percent through September pale in comparison.
Still, many allocators who assemble their own bucket of hedge funds have been satisfied with their consistent performances.
Cedric Dingens, head of global investment solutions who oversees alternatives at the $12 billion Swiss-based NS Partners, says the firm’s profitability during the first three quarters of the year has been driven by hedged equity exposure, especially in the U.S.
“While rate cuts so far have not been as sharp as we expected due to sustained U.S. economic strength, we’ve also been profiting from the steepening yield curve,” says Dingens.
Patrick Ghali, managing partner at the London-based investment advisory firm Sussex Partners, has also seen his hedge fund exposure generate solid returns. In addition to benefitting from U.S.-focused hedged equities, he’s also gained from fixed-income relative value strategies and regional stock markets.
The Top 50’s gains of 9.2 percent over the first three quarters of the year are on pace to match its trailing 3-year and 5-year trailing annualized returns through 2023 of 12.3 percent and 13.7 percent, respectively.
But the results for the broad market in 2024 will likely blow past its trailing 3- and 5-year annualized returns of 10 percent and 15.7 percent.
The same is true for the average hedge fund, according to BarclayHedge, which rallied 9.5 percent led by emerging markets, equity long-bias, and fixed-income arbitrage. The average hedge fund also is on pace this year to beat its 3- and 5-year annualized returns through 2023 of 3.4 percent and 6.3 percent, suggesting increased correlation to the market.
According to BarclayHedge, the average hedge fund correlation to the S&P 500 over the past five years through 2023 was already a very high 0.91. In sharp contrast, the average market correlation of the Top 50 was 0.31.
The Top 50’s emerging market funds continued to outperform all other strategies year-to-date through September, delivering gains of 13.3 percent.
Up more than 24 percent through September, Genna Lozovsky’s Sandglass Capital (ranked No. 33 in this year’s survey) was a key driver of EM returns.
Managing the only fund that topped the market in 2024, Lozovsky explained that gains were driven by sovereign debt investments in Argentina, Sri Lanka, and Ghana, and corporate credits in Brazil and Ukraine. Equity exposure in Argentina and Kazakhstan also helped.
The manager told Bloomberg that he believes there’s more upside in investments in countries that continue to pursue structural reforms coupled with economic growth supported by an improving global outlook.
Relying on idiosyncratic investments, says Lozovsky, is key in identifying opportunities in distressed credit where there’s been wide performance dispersion.
Waha Emerging Markets Credit (No. 37) and Enko Africa Debt (No. 18) funds have also rallied more than 15 percent over the same period. Portfolio manager Mohamed El Jamal said he has benefitted from significant spread tightening and large inflows into EM bonds following the Fed’s first oversized rate cut, which “precipitated strong demand for all high-yield and investment grade assets.”
Even though the number of anticipated rate cuts through 2025 has been pared back, which has dampened a bit of the euphoria, El Jamal sees, “the backdrop as constructive for EM Credit.”
(Waha’s 6th-ranked MENA Equity fund, which has made the Top 50 since 2018, is having an uncharacteristically off year. It’s been flat through September while the BarclayHedge MENA Index has climbed by more than 14 percent.)
Craig Stanley, COO at Enko Africa, also found the Fed’s easing as “supportive of risky assets with both the hard currency and local currency indices posting strong returns in September.”
An increasingly benign EM credit environment, he explains, has “helped African high yield outperform, with Kenya and Egypt outperforming over the period after their relative underperformance.”
Stanley cautions “the escalation of the conflict in the Middle East has increased risk to an otherwise supportive global outlook.”
Equity and credit-fixed income strategies each returned around 10 percent.
High-yield credit shop Millstreet Capital (No. 17), which has qualified for the survey since the current parameters were adopted in 2018, generated returns of 11.3 percent through September. Millstreet now has made money for 18 straight months.
In part, the fund’s consistency comes down to a disciplined credit selection process that maintains a low average duration of 2.1 years and average maturity of 3.3 years.
In response to the late year rally, co-portfolio manager Craig Kelleher says the fund is adding marginally to long positions whose prospects appear to be improving as spread compression over the past quarter declined by 55 basis points. “We’re also increasing our short exposure as the strong rally in the market created more opportunities with many over-levered credits now trading at or above par,” explains Kelleher.
Greenlight Capital’s David Einhorn expressed the most caution. His 10th-ranked hedged equity fund gained 9 percent through September. “The market isn’t just making all-time highs,” wrote Einhorn in his third-quarter letter, “it’s, by many measures, the most expensive stock market that we have seen since the founding of Greenlight (in 1996).”
While not anticipating a bear market, Einhorn believes now is not a great time to have a lot of equity exposure. But he does expect more attractive buying opportunities later next year.
[Read When a Remarkably Consistent Fund Fails]
How long will investors propel the current rally?
Economist Ed Yardeni has tossed aside his usual restraint and has gone all in. He predicts the S&P 500 will end this year at 6,100, reach 7,000 in 2025, and add another 1,000 points in 2026. He sees corrections along the way but nothing that will likely derail the trend.
More uncertainty is expressed by David Kelly, chief global strategist at J.P. Morgan Asset Management, who thinks even partial implementation of Trump’s proposed policies, “would likely result in sharply rising government debt and the potential, in some areas, for building economic and market risks.”
Combining this scenario with the post-election rise in U.S. equity valuations, Kelly thinks, “investors would be well advised to continue to rebalance portfolios both across asset classes and around the world.”
(We just got a preview of that risk when Trump and Musk attempted to eliminate the Federal Government debt limit to keep the government from shutting down before Christmas.)
New policies that seek to spike an already robust economy and market could lead to overheating, fears PIMCO chief investment officer Dan Ivascyn. He notes the sell-off that’s occurring in Treasurys just as risk assets have soared in anticipation of likely tax cuts and universal import tariffs.
With U.S. equities richly valued, Anthony Novara, partner and research director at the $330 billion Chicago-based Fiducient Advisors, doesn’t see many compelling opportunities.
Besides rising inflation concerns under new Republican leadership. NS Partners’ Dingens fears a resurgence of U.S. instability under a Trump presidency that will spread beyond America’s borders.
While gloomy about core European investments, Dingens says Spain, Portugal, Greece, and Ireland are increasingly attractive.
Republican policies to cut regulations and taxes will likely provide a boost to markets and merger activities, says Sussex Partners’ Ghali. But he thinks the potential for broad import tariffs will fuel trade wars and volatility.
Maintaining significant levels of cash, Sussex will keep half its exposure in the U.S. with a portion targeting small- and mid-cap investments. Between one-quarter to one-third of the firm’s exposure remains focused on Asia, with a bias towards under-researched and more thinly traded Japanese stocks. Sussex also is constructive about CTAs focused on niche markets that execute more short-term trades and take little overnight risk.
Even with the likely sharp change in U.S. economic policies and related market implications, Novara doesn’t see Fiducient materially repositioning its current exposure. It intends to sustain half its hedge fund exposure in credit and fixed income strategies, one third in equity market neutral and low-net strategies, and around 10 percent in uncorrelated strategies, including discretionary macro and volatility traders.
Berkshire Hathaway has stockpiled $325 billion in cash, a record. As David Einhorn recently told investors, Warren Buffett has an uncanny ability to do what even he says can’t be done — time the market.
Einhorn recalls Buffett having closed his fund by the end of the 1960s, sidestepping the ensuing lost decade. He again sold “nearly everything” before the 1987 crash. And he was well positioned to exploit opportunities after the 2008 financial crisis.
For investors who think the current euphoria can’t be wrong, it may be worth noting the thoughts coming out of Omaha.
