Last year was one of the best years since the financial crisis for the stock market.
It was also a good year for hedge funds. According to preliminary data supplied by HFRI, the HFRI Fund Weighted Composite Index gained 1.8% in December, leaving it with a 2019 rise of 10.4%.
This is the most robust performance since 2009, when the index returned 20%, although hedge funds on average still underperformed the S&P 500 (which returned 31.5% during 2019).
However, beyond the headlines, performance differed significantly from one hedge fund to the next.
Different performance
I've seen some hedge funds reporting gains of more than 50%, while on the other hand, some managers have lost a significant amount of money.
Two of the funds that underperformed the equities market in 2019, and indeed almost every other asset class, were Russell Clark's Horseman Global and Crispin Odey's Odey European. These hedge fund managers have earned a reputation for being bearish managers who outperform during times of market stress.
Odey, for example, saw the value of his funds rise by more than 50% in 2018 as markets around the world tumbled. This performance pushed the hedge fund manager to the top of the hedge fund leaderboard for the year
Still, in 2019, both managers struggled because they had sizeable negative exposure. Betting against the bull market cost Clark and his investors 35% in 2019, according to official figures, the worst performance for the hedge fund on record.
Meanwhile, Odey's flagship fund declined by around 10% in 2019, according to initial estimates.
These performances showcase the dangers of betting too strongly against a bull market. What's more, they also tell a cautionary tale of how leverage can significantly impact your returns. Both of these hedge funds have borrowed significant amounts of money to fund negative bets on markets.
Odey frequently makes use of derivatives to increase the size of his bets against interest rates and currencies. This is why he was able to achieve a performance of more than 50% in 2018, but it has come back to haunt him in 2019.
The world's most bearish hedge fund
Horseman was once described as being the world's most bearish hedge fund. Clark and his team maintained the firm's short positions in 2019 despite the market's aggressive rally.
Rather than picking just a few companies with bad prospects or possible frauds, Clark tends to own hundreds of positions, which is more of a directional bet on the market than a strategy based around individual equity holdings. In October, as the stock market was rushing to new highs, he boosted his net short position to 111% of gross assets.
Following 2019's poor performance, Horseman's assets under management have shriveled to just $240 million, down from nearly $2 billion in 2015.
Buffett's investing principles
These two funds have violated two of Warren Buffett (Trades, Portfolio)'s investing principles. Firstly, they borrowed money to invest and secondly, they've shorted stocks.
At the 2006 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting, Buffett said:
"There's nothing evil about short-selling. But it's a tough way to make a living. It's tough emotionally. If you short a stock at $20, the most you can make is $20, but there's no limit to how much you can lose.
Historically, a lot of stocks that have high short interest are later shown to be frauds or semi-frauds. I've had 100 ideas to be short, and have often been right -- eventually, but long after I've covered, and the stocks have risen a lot. The people who run those companies tend to be good at keeping their stock prices up."
The best lessons are those we can learn from other investors because we don't have to put our own money on the line. The lesson here is that the rewards of shorting stocks are not worth the extra time, effort and money required to sustain a position for the long haul, especially if you're shorting with borrowed capital.
Disclosure: The author owns shares of Berkshire Hathaway.
GuruFocus 15-year anniversary promotion
The holiday season is here, and so is GuruFocus’s 15-year anniversary! In order to celebrate, we are offering an exclusive holiday discount of up to 30% off on our GuruFocus Premium Membership.
Join now to get GuruFocus Premium membership for only $399/Year! In addition, save an extra $100 when you upgrade to our PremiumPlus Membership, and enjoy $100 off the price of each additional region you add to the subscription.
Don’t miss out on this once-in-a-decade deal! You can sign up for the discount price by clicking this link. Happy holidays!
Read more here:
