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I listened to a number of presentations concerning crisis alpha and crisis offset at a recent hedge fund conference. The idea of holding assets and strategies that will do well in “bad times” is a critical issue for any portfolio construction discussion. It is the bedrock and foundation of any portfolio that attempts to protect against bad states of nature, control risk, and gain during good times.

There has been much discussion about benchmarks and beta with hedge funds, but it is important to take a step-back and discuss how active returns are generated. Active management can be divided into two parts, the style used and the skill employed within that style. You can call a style a risk premium as is the case for value or small investing; however, all returns from styles may not be from risk premiums. Style is simply a descriptor or means for generating returns. Skill comes with the method of employing the style. Within a style, some managers are better at it than others.

Most of our quants have a computer-science background. They can code in either Python or C++. Whereas on the discretionary side most of them come from a more traditional investment-banking background and are digging into 8-Ks and company fundamentals and being able to look at companies from a bottom-up perspective as compared to trying to use many different data sets to help predict the prices of stocks.

-Ryan Tolkin CIO Schonfeld Strategic Advisors

As the old joke says, “There are only two types of people – those that type others and those who do not.” However, this dichotomy may be applicable for current money management. There are two camps of analysis, the quants who are looking for repeatable behavior in data and the discretionary analysts who are looking for unique or special situations across markets. The quant plays the averages and the probabilities while the other places value on what cannot be counted and handicapped. One focuses on the numbers while the other looks for the firm story as a thesis for investing.

So you see a manager with a good Morningstar rating. It has five-stars. Should an investor care? Past performance is not indicative of future returns, so should it matter if you had highly rated past risk-adjusted performance?

Certainly, a rating is not definitive, but as a heuristic on a fund’s relative performance, there is positive information to be gleaned from ratings.

There is difference between theory and practice. The academic research study that identifies an obvious new risk premium may be difficult or impossible to implement in practice. The good firm is able to separate theory and practice and avoid implementing bad ideas. They will have a feel for whether it can be done in practice.

Behind the backdrop of the vast changes in monetary policy over the post Financial Crisis period has been the movement to improve the regulatory environment for financial markets in order to reduce systemic risk. Significant work has been done to improve monitoring and rules to eliminate excessive speculative behavior, but as more regulations are proposed and more changes to the financial system are made, there is demising marginal benefit and a greater likelihood for unintended consequences. A rule that makes sense for one group may lead to a shift in risk capital and changes in behavior toward unregulated areas. Simply put, risky behavior will shift to the places where the cost of speculative behavior is least.

As a more quantitative focused analyst, I keep focus one thing – the numbers. Stories are good, but numbers are better. At best stories, provide context for numbers, but stories of politics will not lead to market trends. Capital flows on trends in profits, growth, liquidity, and risk. Do not suffer from “shiny object” syndrome. The news of today may not impact the important fundamental trends.

While large cap and international stocks continued to move higher, the markets are starting to see more dispersion with small cap, growth, and value indices all posting negative returns for the month. The Russell value index has fallen to negative returns for the year. A growing dispersion is also evident in sector and country returns. Bonds have been a safe asset with positive gains for the year across all sectors. The returns are consistent with slow but positive growth around the world with controlled inflation.

May was a mixed month for many trend-followers. Some did well while others got caught on the wrong side of mid-month reversals. The month saw a mid-month equity sell-off which could have stopped-out a number of key positions in equities and bonds. This sell-off was based on political uncertainty and not macro fundamentals.

Money has flowed into managed futures under anticipation that there will be a crisis event that will need the diversification benefits of trend-following strategies. These investors adjusted portfolios away from perceived overvalued assets to the value from long-short diversified trend-following. What is the sense of increasing allocations after the divergent event of a equity sell-off?

Call it the “Global Rotation”, but last month was a continuation of what we have seen for the year. There has been a flow of money into international stocks and increasing divergence between the rest of the globe and US risky assets. There is a dollar adjustment component to these returns, but there is no mistake that there is a preference for cheaper opportunities around the world.