A decade of Hindsight Capital’s winners and losers

Hindsight Capital beats the market, and all competition, every year. But how would it do over a decade?

For the uninitiated, Hindsight Capital is an imaginary hedge fund that is blessed with perfect foresight, which features at this time of year in the Long View column.

As real fund managers deploying real money have to hedge their bets, it always does far better than any of them can do. But the exercise begs the question of what trades hindsight would dictate over the longer time periods. Here, then, is how Hindsight Capital would have fared over the past decade.

Bet on the US

US large-caps (as in the S&P 500), and small-caps (as in the Russell 2000) returned 97 and 98 per cent, respectively, far outpacing the rest of the world (up 7.8 per cent according to MSCI), Europe (6.3 per cent, using the FTSE Eurofirst 300), or even the Emerging Markets (which returned 19 per cent). Europe’s total market capitalisation had marginally overtaken the US at the time. This was obviously overdone.

Bet against oil

Crude oil (measured by the Bloomberg total return index) lost a stunning 75 per cent over the decade. It was nearing the top of a long bull market 10 years ago. Anyone who bet that this would spark a search for new energy sources, which would benefit the US more than anyone else, would have been richly rewarded. A trade of shorting oil and putting the proceeds into the Russell 2000 would have made 720 per cent. This was the trade of the last decade.

China’s domestic market was a home for the brave

China’s A-share market, to which foreigners still have only limited access, has twice collapsed after forming bubbles over the past decade. But for those who hung on, it made money. According to MSCI, China A-shares are up 86.7 per cent in price terms over the past decade, beating even the S&P. This is almost entirely due to the ebb and flow of Chinese investors’ emotions; the MSCI China index, reflecting stocks traded in Hong Kong largely by foreigners, is up only 11.1 per cent.

The eurozone crisis was a disaster that keeps giving

During the worst years of the eurozone crisis, there was huge money to be made by buying insurance against default by the peripheral European countries. Buying the debt back made a profit as the crisis diminished. Over the full 10 years, the damage to the stocks of the affected countries has been severe and lasting. According to MSCI, Greece’s was the world’s worst performing stock market, losing 97.2 per cent. Portugal (down 70 per cent), Ireland (-68.6 per cent), Italy (-64.5 per cent) and Spain (46.3 per cent) also suffered grievously. A confident bet against the eurozone would have been very profitable.

Some broader lessons from the exercise

Don’t forget bonds

Over the past 10 years — which did include a financial crisis and a long period when central banks artificially supported the bond market — US bonds performed better than stocks for most of the time. In three of the last 10 years, they were the world’s best performing broad asset class. They play a greater role than many believe.

But don’t treat bonds as low-risk

There were also two years when bonds were the worst performer (including this year). At this point, bonds look similar to oil or other commodities 10 years ago, and might be due for a long drawn-out correction. (Similar arguments apply to gold; it is a very valuable diversifier, as the last decade shows, but it is not “low risk”).

Asset allocation from year to year is no easier than stock picking

Variation in performance from year to year is extreme, and cannot be explained by regression to a mean, or by economics. You need to be able to predict when sentiment will turn — and that is maddeningly difficult.

Full details are in the heatmap of how 10 main asset classes performed over the past decade.

Contrarianism can work

Commodities were generating great excitement a decade ago. In the decade to the end of 2006, industrial metals and oil had made 286 and 261 per cent, respectively, beating every other asset class. Money was pouring in. They were widely considered a new asset class to which all long-term funds should allocate some money, alongside stocks and bonds. Betting against them took nerve but would have paid off hugely in the last decade — metals dropped by almost a half and oil did worse.

It is also true that, each year, Hindsight makes money from trades that look massively contrarian. This year, coal appeared dead and clean energy was the future. So international coal stocks doubled while clean energy stocks fell more than 20 per cent.

But contrarianism has limits

Trends can carry on for a while. Generally, money is made slowly over a long time and lost in a hurry. Betting against last year’s winner is dangerous. A naive policy of shorting last year’s winner, and going long last year’s loser, lost money in six of the last nine years.

Commodity investing for the long term has a problem

These figures are all on a total return basis, reflecting the money investors would actually have made. It costs money to hold commodities. When investing through futures contracts, on which commodity indices are based, this meant that oil suffered a serious loss over the past decade and barely even made any money last year.

Even long-term pictures can turn swiftly — don’t try to catch turning points

If this exercise had been carried out on the day of the US election, long bonds would have won. Their total return exceeded that for the S&P 500 by more than 15 percentage points while gold had beaten the Russell 2000. The sharp rally for risk assets since then, accompanied by a sell-off of bonds, shook everything up.

The moral — don’t try to catch the turning points. In the long run, a sensibly diversified portfolio will do fine. And don’t worry about the hugely superior returns you could have made with hindsight.