The idea of running a hedge fund, or of being a client of a hedge fund, sounds promising: Huge rewards year after year, the promise of fast-growing riches, and perhaps even of early retirement.
But, reality intrudes, as the old saying goes. If you had invested in many of these funds since the 2008 crash, you’d be wishing you’d just bought an S&P index fund. The SPY index has outperformed many of the once-hot hedge funds since the bull market began in 2009.
Paul Tudor Jones (Trades, Portfolio) runs one of those currently underperforming hedge funds. His global macro strategy generated high returns for some 20 years, as he correctly anticipated 1987’s Black Monday and the Japanese market crisis of 1990. Since 2009, though, the strategy has failed to consistently beat the S&P 500 index.
Who is Jones?
The guru, born in 1954, received an economics degree at the University of Virginia in 1976. His father operated a financial and legal newspaper; Paul contributed to it while in college, using the byline, "Eagle Jones". He was later accepted to Harvard Business School, but declined to attend, believing he would learn more from trading.
He began working as a Wall Street trader in 1976, then became a broker for E.F. Hutton & Company. During this period, Jones met noted commodity trader Eli Tullis, who became his mentor. Tullis later hired Jones to trade cotton on the New York Stock Exchange.
In 1980, at the age of 26, Jones set out on his own, founding Tudor Investment Corporation; this hedge fund, along with affiliate firms, collectively, are The Tudor Group.
He won early acclaim for correctly anticipating Black Monday of 1987. Because of his many short positions, he tripled his money, however, he credits the call to his associate Peter Borish. Jones says Borish mapped the 1987 market against the 1929 market, and found striking similarities.
Bio based on information at Investopedia, Business Insider, and Wikipedia.org.
Comments: At a relatively early age, Jones became a trader, entrepreneur, and manager. With credit for anticipating Black Monday, he earned guru status quickly and moved on to conquer more trading challenges.
What is The Tudor Group?
Tudor Investment is described at MarketsWiki.com as "a large manager of hedge funds " and that it invests, across global markets, in:
- Equities,
- Derivatives, and
- Forex.
The site also reports Tudor Investment agreed to fines worth $800,000 to the SEC for "mistaken trades" in 1994, trades that pushed the Dow Jones Industrial Average down 16 points in just one day.
Tudor was a founding partner in the creation of the Green Exchange in 2007, a market in which environmental derivatives could be traded (the Exchange is now owned by CME Group Inc. (CME)).
Comments: Because hedge funds are exempt from many of the trading and reporting rules faced by other types of funds, they enjoy a great deal of freedom in where and how they invest. At times, though, that freedom can lead them out of bounds, resulting in financial and reputational damages.
Strategies & tactics
Jones laid out some of his investing strategies and tactics in an interview with Institutional Investor magazine (2009); it was reposted in Climateer Investing in 2016.
He loves macro trading, saying that if conventional trading is like playing chess, then macro trading is like three-dimensional chess. And, he says "tape reading", is essential to those who want to succeed at it. Jones says, "While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it."
In an article for TheStreet, Malandrino and Najarian define tape reading as the unemotional analysis of trends in stock valuation, trends driven by the velocity of change and the intensity of the change. Essentially, that means watching price trends and momentum. Tape reading used to involve watching the ticker tape roll by; now, it's often the stock prices scrolling along the bottom of a computer screen.
In his case, it's not just macro, but global macro, which adds another dimension to the strategy. He says the advantage and disadvantage of global macro is that “It Is Not Easy” (because it’s not easy, it also offers bigger rewards). Adding to that, he says macro investors must pay attention, and understand the interrelationships among markets, politics, weather, and psychology. Further: You must be humble enough to take in the lessons the market will teach you. And, you must avoid trying to impose your will upon the market.
The younger generation of macro traders suffers a disadvantage, Jones theorizes. He says younger traders are a step behind because they want to understand and rationalize why a security might go up or down. By the time that becomes evident, he says, the opportunity has already passed by. He also observes there are now many more deep intellectuals and an explosion of information, because of the Internet. That leads many to believe their main task is find explanations; as a result, they're not prepared to "close their eyes and trust the price action".
When asked whether hedge funds will do as well as they have in the past (presumably the question was asked and answered in 2009), he doesn't think they will, generally. He points out hedge funds made so much money in the previous 30 years that they have attracted the world's best intellectual capital. This means extra sharp eyes hunting for inefficiencies, and there are bound to be fewer opportunities. Nevertheless, Jones adds that the top 10% of 20% of managers will continue to best everyone else.
Asked about the biggest influence in his career, Jones point to Eli Tullis, who was the biggest cotton speculator in the world at the time Jones went to work for him. The most important takeaway from his time with Tullis was learning to keep his cool in times of great stress, particularly when losses were mounting.
His best single trade, he says, was to buy “put” options on the Japanese stock market in February 1990. The biggest missed chance was a failure to short the market as the subprime crisis built in 2007; he says he's still rankled every time he hears the term.
Looking to the future, Bloomberg Markets reports that Jones, "reeling from sluggish returns and client withdrawals", is planning to launch a macro hedge fund that uses machine learning, or artificial intelligence.
An Investopedia article sums up Jones’ global macro trading style, noting it has little to do with either growth or value investing strategies. Instead, it is based mainly on technical analysis, with extra emphasis on momentum factors that drive markets.
Comments: As a hedge fund manager, Jones has opportunities to go both long and short. Combine that with the vast number of variables present in global macro trading, and you have a position in the investment universe that can’t easily be challenged. Jones made the most of that advantage in his first twenty-some years.
Holdings
This GuruFocus chart shows the weight of non-common stock holdings in Jones’ portfolio:
This table from NASDAQ.com shows Tudor’s top 10 holdings:
The two ETFs are the SPDR S&P 500 (SPY, Financial), and the Materials Select Sector SPDR (XLB, Financial).
Comments: By valuation, the SPDR ETF makes up almost 40% of the top 10 holdings. Assuming this is a long position, it means Jones still sees growth ahead in his analyses and tape reading. If short, it suggests a big bet on a future pullback.
Performance
Because Jones is a hedge fund investor, regular performance reports are unavailable, but it is possible to find enough fragments to get a general sense of those returns.
As we’ve seen, he delivered outstanding returns in his early years, results highlighted by his huge bets on Black Monday and the Japanese market in 1990.
GuruFocus reports his BVI Global Fund lost nearly 5% in 2008, but that was still 32 points better than the performance of the S&P 500 that year.
In an undated (but likely late 2016 or early 2017) article, MarketWiki.com cites a no longer available Bloomberg source to say Jones’ Raptor fund had average annual returns of 27% between 1987 and 2007. However, between 2008 and 2016, that average dropped to just 5.3%; over the latter eight years, assets under management also plunged, from nearly $20 billion in 2007 to about $11 million in 2016.
2017 apparently hasn’t been any kinder. In an August 1, 2017 article, Bloomberg Markets reports that the BVI fund held just $3.6 billion of client assets at the end of the second quarter, roughly half the value they were at the beginning of the year.
Comments: The most important trend of all, from a Tudor perspective, is the growing curve of withdrawals. Which leads to the question: How do you maintain your strategy—and returns—while your capital drains away?
Conclusion
We’ve noted that global macro trading is a complex business; in fact, Jones describes it as three-dimensional chess. Did complexity grow so much since 2007 that this is no longer a feasible strategy? Has there been a watershed moment in hedge fund investing? Or has the fault been with his individual trading strategy or style?
In the case of Paul Tudor Jones (Trades, Portfolio), it’s quite possible all three of those factors, and perhaps others, have brought at least some of his returns below those of a basic index fund.
Hedge fund investing is not what it used to be, and Jones’ strategy and style provide few useful insights for individual or professional value investors.
Disclosure: I do not own shares in any of the companies listed in this article, and do not expect to buy any in the next 72 hours.
