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Hedge funds as measured by the HFR indices suffered with the overall market decline with only RV strategies being able to take advantage of the higher volatility environment. In general, the equity hedge fund declines were consistent with their longer-term betas (approximately .3 to .6). The outliers for the month were the event driven, special situations, macro and systematic CTAs indices. The year-to-date returns show significant dispersion with equity hedge fund indices generally positive while special situations, systematic CTAs, and event driven indices falling between -2.50 and -3.75 percent.

February was a bad month for investment performance. All of the major ETF indices we normally follow were negative. Diversification was an elusive concept and reinforced the key portfolio allocation risks of rising correlation. There is no positive spin with these numbers other than less risky assets like bonds fell less than more risky assets, although year to date numbers show that bonds have not been a safe haven. There are a few takeaways from the month:

How would you feel about your investment portfolio if you went to sleep at the beginning of the year and woke-up on Friday? What if you stuck your portfolio in a drawer and pulled it out after three months or a year to look at performance?  My guess you would say you were happy and comfortable with your investment decisions, yet there has been a lot of investor anxiety this month.

There was a clear financial shock to the market with the spike in the VIX index earlier this month, but the market has reversed a significant portion of the earlier losses. From the SPY high in January, the market declined about 10.5%. There has been a reversal of 6% so the stock market is now positive for the year and only down 4.5% from the high and down 2% from month-end.

Wall Street is filled with characters and “personality”. I have met my share, but a key question is whether some of these personality extremes actually lead to better returns. I have written about this in my posting The Wisdom of Psychopaths and Trading. Some have suggested that the characteristics of psychopaths if directed toward good goals may lead to successful outcomes. The core idea is that a lack of empathy or emotion found in psychopaths is actually good for some jobs. Certainly, there is a strong strain of thinking that trading should be without emotion. Hence, personality characteristics such as less emotion or empathy may be good for return generation. You just may not want to have them as your boss.

Some may say, “A bond is a bond, is a bond”. Investors may place risky assets in one category and then have bonds in a less risky category. This dichotomy does not focus on the important distinctions between bond groups and the roles that different bond categories may play nor does it present the possible trade-offs between return, risk, and correlation within a portfolio from different bonds.

The dollar may be trending down, but investors should also look at the second order effects of what will happen to other markets. For example, a declining dollar is good for long commodity exposure. The long commodity argument is twofold, one, a decline in the dollar makes commodities denominated in dollars cheaper to foreign buyers which will increase demand; two, a decline in the dollar associated with global growth will increase global commodity demand. There are both substitution and income effects.

We have not heard from the “bond vigilantes” in quite some time. The origin of the word vigilante is Spanish for watchman, alert, or guard, and like a watchman they have been out there waiting for the long combination of events. The definition of bond vigilantes is a broad term for bond market participants who impose discipline on the market through focusing on negative fundamentals. Their form of discipline is selling duration or not buying at current levels.

Many commentator have talked about the fact that stocks and bonds moved together during the current market sell-off as if this is big news, highly unusual and signal of market change. A positive correlation is not the normal relationship we have seen in the post Financial Crisis period, but it may be a little early to say there is a sea-change in market behavior.

Risk parity has had good performance over the last two years with double digit returns after stumbling in 2015, yet the diversification strategy of equal weighting of four major asset classes has been painful this year. Diversification based on weighting risks offers some protection but is not cure for a volatility revaluation.

When asked for money, WC Fields once said, “Sorry good man, all my money is tied up in cash.” 

Hedge fund performance, as measured by the HFR indices, showed strong performance in January especially for global macro and systematic CTAs. Systematic CTAs also generated returns that were in the top three categories for the last twelve months.

Equities started the year with strong performance across style, sector, and country groupings; however, there were some exceptions to these gains and also some signs of potential for performance declines. Bond ETF returns were all negative except for international bonds which gained from the dollar decline. These returns are consistent the fundamental story of strong growth and expected higher inflation. There will be peak and valley in return even with the clear story, but the general direction is still risk-on for equities and avoidance of duration for bonds.