Stock market activity for June was a tale of two markets. The first 26 days of the month were characterized by stock prices falling 8% as the market wrestled with the crisis in Greece and the ending of the Fed’s QE2 program. On June 21, Greek Prime Minister George Papandreou survived a no-confidence vote leading to the subsequent passage of a Greek austerity package. Despite days of rioting in Athens, the markets viewed the austerity (more specifically the cash infusion Greece will receive because of it) as a major positive and rallied 6% in the last four trading days – ending the month with a 1.6% loss.
As investors returned to embracing risk, the expiration of QE2 put substantial pressure on the bond market. During the last four days of the month, yields on the 5-Year Treasury rose from 1.37% to 1.76%. Thus far, the end of QE2 has had the most impact on the short end of the yield curve, though longer-dated maturities have fallen in value as well.
From a macro perspective, the resolution of the Greece’s mid-term fiscal plan takes some pressure off European Banks and the possible spill-over into U.S. money markets. The 12 billion Euro bailout tranche expected to be delivered in early July will cover Greece’s financing needs until mid-August. Meanwhile, the French have floated a plan for holders of Greece bonds to roll-over 70% of their maturing bonds in exchange for receiving 30-Year paper in a special-purpose vehicle with a minimum yield of 5.5%. This idea, while elegant, is not without its problems. First, it is not clear that the ratings agencies would let this restructuring occur without declaring it a default. Second, the plan would require the European Central Bank to hold its Greek debt to maturity – and it is questionable that the ECB would agree to such a restriction. Third, the interest rate that will be required on the rolled-over debt will be a significant burden on Greece. Considering these factors, Greece remains a point of interest from a risk-control standpoint.
As this is the end of the second quarter, we will be watching corporate earnings reports quite carefully for signs that the economy is not sliding back into recession. The lack of negative guidance leading up to the quarter-end has been encouraging, but the expectations for strong earnings have set the bar rather high.
Altair Hedged Equity’s 10th Anniversary
June 30 marked the 10th anniversary of Altair Hedged Equity’s launch. For me, that milestone brought two things to mind: First, it warrants a sincere “thank you” to the clients who have trusted us over the past decade with stewardship of their wealth. We are fortunate to have a great client-base that has stood with us through what can only be characterized as an “interesting” decade. Second, it seemed like a good time to reflect on where the Fund has been over those years. Viewed from the tree-top level, we’ve been through two bear markets and two bull markets – all of which tended to be fairly dramatic.
The Fund’s focus on delivering consistent returns was tested immediately upon its launch. From July 1, 2001 to October 9, 2002 the stock market dropped by 37% as the tech bubble burst. Hedged Equity made it through that stretch with a total loss of 6.8% and was back to break even eight months later.
From those October 2002 lows, the stock market went on a four year bull market run – gaining over 101% before reaching its apex October 9, 2007. During that same timeframe, Hedged Equity posted gains of 73%.
Next in line were the financial crisis and the associated bear market in stocks. From its peak to its nadir on March 9, 2009 the stock market shed nearly 57% of its value. Hedged Equity traversed this bear market with a 9.3% decline in value. That 9.3% decline proved to be the largest drawdown Hedged Equity would have experienced in its history, and was recovered in 14 months.
Finally, we had QE2 and the stock market’s melt-up. With remarkable persistence against major macro-economic headwinds, the market nearly doubled – adding 95%. This period, from March 2009 through June 2011, represented Hedged Equity’s most difficult time-frame from a relative performance perspective – as the Fund increased by just over 15%.
Taking these four cycles together, the stock market is up 31% since our launch, while Altair Hedged Equity has gained 69%.
And while we take a modest amount of pride in the totality of our work over these past 10 years, we continually apply a critical eye to our performance; both in relative and absolute terms. The basis of this critique is always in the context of our stated objective: To deliver consistent of returns over a full market cycle.
During the past few quarters, I have had some enlightening conversations with our clients. Some shared our cautious macro view; others became increasingly uncomfortable with the disparity between our Fund’s returns and those of the stock market. One such conversation involved a gentleman I’ve known for the past 28 years and who has been a client for the past 10. He was the boss at my first job out of college, became a business associate in later years, and ultimately a client. Because of our history, we speak quite candidly. The crux of the conversation came down to this: his overall target rate of return when we began working together was 8%. With the losses incurred during the financial crisis, his annualized return was closer to 6%. He viewed the past 27 months as an opportunity for his portfolio to “catch up, ” and we failed to keep pace with the market.
As is often the case in relationships that began in a mentor/student environment, the client took the time and effort to help me dissect the Fund. We discussed our macro view in great detail. We went down the list of our sub-advisors one-by-one, covering their strategies, their performance, and their outlook. We shared our thoughts about the future of interest rates, equity valuations, commodities, and the regulatory environment. In the end, we agreed on nearly every philosophical and mechanical point – we just could not reconcile the disconnect in relative performance. Ultimately, we decided to part ways, remain friends, and I worked closely with his new advisor to insure a smooth transition. The client did reserve the right to come back to Altair at a later date if he had a change of heart!
I share this story because I think it is important to provide some insight into what we have been thinking lately. That includes our self-analysis as well as the acknowledgement that some of our clients have sincere questions about our relative performance since March 2009.
As I mentioned earlier, consistency of returns is our primary objective. To achieve that objective, we use the same tools in both bull and bear markets. Those tools include diversifying to avoid unique risk, short-selling to reduce systemic risk, and sourcing returns from areas unrelated to the direction of the stock market. Sometimes, like 2002 and 2008, the success of this approach is gratifying. Other times, it is one of the most difficult parts of our job. But how we feel about our strategy over different time frames is largely beside the point. We are paid, to put it quite simply, to assess possible outcomes, assign probabilities to those outcomes, and allocate capital in a way that reflects these probability-weighted outcomes.
There is nothing emotional about that process. Whether the feeling is fear like that after the collapse of Lehman, or joy as the stock market doubles, succumbing to the emotion would lessen the likelihood that we could continue to deliver consistent returns. And if we fail at that, we would forfeit our reason for existing as part of someone’s portfolio.
So, as Hedged Equity starts on its second decade, I want to thank you all again. And, as always, I invite you to call or stop in for a visit if you have any questions or comments.