Each year at the Ira Sohn conference a group of the world’s best known hedge fund managers present their top ideas for what to buy in the stock market. The event is so closely followed by investors that it is not unknown for shares in companies that are picked to start rising before presenters have even left the stage.
More recently, however, some of these celebrity investors have picked shares that have performed so poorly that they would have struggled to summon worse trades if they actively had tried.
In 2015 Bill Ackman, the New York-based hedge fund manager, encouraged audience members to bet on Valeant Pharmaceuticals before its shares lost more than 80 per cent of their value. At a different conference the year before David Einhorn had evangelised about SunEdison, The solar company that later filed for bankruptcy protection.
These high profile stock picking failures have come at a time when a growing number of clients of investment companies have started to question the entire premise of paying fees to fund managers to try and beat the performance of the broad market.
Money has been pulled out by investors in hedge funds and a rising number of fund managers have lamented treacherous, central bank-led market conditions that have made it difficult for stock pickers to succeed.
Now, as 2017 approaches, it appears that stock pickers have been filled with a renewed optimism. An increasing number of active fund managers are optimistic that they will be able to take advantage of changing market conditions following the US election to press their edge in stock selection in 2017.
“A market previously obsessed with low inflation and bond proxies has to adjust rapidly to a world of rising bond yields and a potential shift away from monetary to fiscal policy,’’ says Dylan Ball, the manager of the Templeton Euroland fund.
This outlook has in part been stoked by the sharp rally in previously unloved cyclically-exposed shares and banks since November that has powered all four major US equity barometers into record territory. The S&P 500 financials sector for example has risen nearly 20 per cent since the US election while the broad market has risen nearly 6 per cent.
For several years stock pickers who tried to identify cheaply priced equities that they thought would outperform the broader market struggled as these beaten down stocks tended to stay cheap.
Many fund managers now expect that this process will start to reverse, meaning they can benefit from picking shares in so-called value companies that have lingered behind more exciting growth shares. Following the pronounced rally in these sorts of stocks over the past two months many are now positioning themselves for the trend to accelerate into next year.
“The market’s prior focus on higher quality/lower volatility stocks left these stocks very expensive and relative to value stocks they were near an all-time high — not too dissimilar to the level reached in March 2009,” says Mr Ball. “And the more value stocks in energy, financials and Europe have rallied, the more investors have had to buy into the rally to close down their relative performance risk. This looks set to continue”.
While the election of Donald Trump has triggered a rally in more cyclically exposed stocks, helping the portfolios of value-focused fund managers, this rotation has also resulted in other shares being left behind. This, in the eyes of some stock pickers, will provide opportunities for patient investors to buy quality companies that are momentarily out of fashion. Large technology companies have notably lagged behind the performance cyclicals and the broad market since November 8, as investors have rotated from growth into value shares.
“In the rush to buy all things cyclical in the wake of Brexit and then Trump’s victory, the market is giving us opportunities to reinforce strong long-term non-cyclical franchises,” says Simon Pickard, an emerging markets portfolio manager at the hedge fund Man GLG. “We have been reinforcing those stocks where we believe short-term pessimism has been overdone”.
The question for the institutional investors who must decide if they want to give these funds their money is — after several false dawns — whether the stock pickers’ renewed optimism is really justified. There have already been several attempts by these types of clients to time this over recent years.
In 2015 investors poured money into equity-focused hedge funds with these funds seeing the highest level of inflows of any single strategy. These funds added a total of $60.3bn of assets last year, according to data from Prequin.
This year faith in the skill of stock pickers has wavered once again as equity hedge fund strategies suffered from $27.4bn of outflows over the first three quarters. The amount of assets managed by the strategy, however, is still up for the year by 2.9 per cent, to $831bn, second only to funds with a macro strategy.
It does finally appear that the factors stock pickers have blamed for their struggles, such as low interest rates and central bank bond buying leading to high correlations between stocks, are receding. The challenge facing many stock picking hedge funds after years of mediocre returns is whether they can convince sceptical clients that this time, finally, it will be different.