Jacob Wolinsky of ValueWalk, who over the years has turned out to be a pretty straight-up blogger/investor/publisher (although for a while he employed a guy who would grab obscure stuff from us without so much as a hat tip) in this piece is being hosted on the Slope of Hope platform:
Editor’s note: This article is part of a series ValueWalk is doing on tail risk hedge funds. The series is based on several weeks of research and discussions with over a dozen experts in the field. All the content will be first available to our premium subscribers and some will be released at a later date for all readers. If you want to see the full series and support us please click here.
Many tail-risk hedge funds posted astonishing gains during the March selloff, with at least one fund reporting a gain of over 3,000%. However, it’s important for investors to read between the lines when it comes to choosing which hedge funds to invest in.
Whenever looking at the returns of any fund, especially tail-risk funds, it’s important to make sure you’re doing an apples-to-apples comparison by using the same measurement of returns across all the funds you’re comparing.
Some tail-risk hedge funds report their returns in a different way than how most hedge funds report their returns, making it seem like their returns are much higher than they actually are compared to other funds.
In some cases, that 3,000% return may actually be more like 30% when switching to the same method for reporting returns that most hedge funds use. You may even discover that the fund that reported the 3,000% return underperformed its peers which reported using the standardized method for reporting returns.
The key is to make sure all the funds you’re comparing are using the same method for reporting returns.
How tail-risk funds report returns
Some tail-risk funds report their returns based on the current premium or initial margin. This is also referred to as return on invested premium. Reporting a return based on this number means the amount of capital that was utilized to get the return on that particular trade.
It can also mean the amount of capital that is utilized through options currently owned. Many tail-risk strategies include the use of options. This return can be in the thousands of percent typically because it’s based on a very small amount of capital. It also means the entire fund didn’t post the return that’s being reported. It’s only a small part of the fund and/ or only the part used for a particular trade.
Most hedge funds report their returns based on notional numbers, meaning it includes the entire amount of what an investor has in a fund at that time. These returns are much lower, and when you see funds reporting 10% or 20% returns, for example, this is usually what is meant. However, it can’t be compared with the 3,000% return based on the current premium because it includes the entire fund instead of only part of it.
One important difference between margin reporting and notional reporting is the fact that investors pay management fees based on notional exposure. Additionally, some tail-risk funds choose to report gains on the premium paid, but then when they have losses (which is most of the time because they serve as portfolio insurance for major selloffs to lessen the blow of the selloff for the entire portfolio), they report them based on notional exposure so they look smaller.
It’s also important to point out that many tail-risk funds that report based on current premium or initial margin may be underperforming their peers when comparing via notional numbers instead of margin numbers.
One other way some funds report is by return on assets under management or return on total invested capital. Under this method, investors fund a certain amount into their funds to cover the annual premium for the tail-risk hedge and additional cash so the mandate is fully capitalized. When the return on current premium is at or near the thousands of percent, returns on assets under management are often in the hundreds of percent.
Tail-risk funds decline to comment
ValueWalk contacted two tail-risk funds to inquire about how they report their returns. Universa reported a net return of 3,612% for March and 4,144% for the first quarter, according to an investor letter that was leaked to the media. If you read further in the letter, you see that the return on total invested capital was 239% for March, but that’s not the return that made news headlines.
A look at a chart that’s included in the letter illustrates how two different methods for calculating returns may have been used to come to the 3,612% return for March and the 0.4% return for the fund with a 96.67% S&P exposure combined with the 3.33% hedge:........MUCH MORE
Our argument against tail-risk funds and reporting is, as usual, a bit more simple-Simon:
If it worked as advertised, just as with ESG investing, it wouldn't be called tail-risk investing, it would just be investing. Ditto for ESG, if it consistently generated superior, or even equal returns it would be known simply as investing.
Here's one of our pieces on the trouble with running that type of fund (or investing in same),
June 1, 2009
Taleb Makes Hyperinflation Bet and Why You Might Want to Be Skeptical
Update here.
Original post:
Be careful!
The first point to be made is This is NOT a Black Swan bet. Black Swan's by definition come out of the blue. Inflation caused by central bank monetary and government fiscal policy is being debated in the HEADLINES!
Second, and more specific, Mr. Taleb is a better marketer than a money manager. His hedge fund returns were opaque* (which considering his self promotion implies they weren't that hot).
First though, the story by Scott Patterson at the Wall Street Journal (emphasis mine):
A hedge fund firm that reaped huge rewards betting against the market last year is about to open a fund premised on another wager: that the massive stimulus efforts of global governments will lead to hyperinflation.........MUCH MORE including a truly brutal takedown
See also:
Where In The World Is Jemima Kelly? (dancing the apocalypto)
As a side note, when dealing in end-of-the-world derivatives always, always demand collateral.
Upfront....
.....MUCH MORE
We are not fans of the typical black swan fund, even as a hedge. Like triple-leveraged inverse ETF's the concept sounds good but having the market's historical upward bias grinding against you can get wearying. Some day this will change but in the meantime here are some thoughts on Nassim Taleb:
More on Nassim "Black Swan" Taleb as a Money Manager
The day the Wall Street Journal broke the news of "Taleb Makes Hyperinflation Bet and Why You Might Want to Be Skeptical" there was a minor kerfuffle about a claim: “...made $20 billion for our clients, half a billion for the Black Swan fund", reported in the British GQ. I didn't understand how that could be and instead chose to focus on his Empirica Kurtosis fund's performance.
We've been tracking Mr. Taleb for quite a while and the general summation is an ad I was going to write for him:
"Here at The PseudoProfound Group, we believe..."
