John Authers, formerly of the Financial Times but now at Bloomberg, conducts an annual assessment of what investment strategy would have worked in the past year, for the fictitious hedge fund ‘Hindsight Capital’ employing something we might all wish we could use to make decisions – perfect hindsight. Here’s how it panned out for 2018.
Hindsight is a beautiful thing
The top three trades for Hindsight Capital were;
- Long US utilities (+4%), short Chinese technology (-38%)
- Long US managed healthcare (+11%), short Japanese marine trade (-39%)
- Long short-dated US treasuries (+1%), short euro-zone banks (-39%)
“Shorting, or short-selling, is when an investor borrows shares and then sells them, hoping to buy them back later at a lower price to pocket the difference.”
On the ‘long’ side, ie. buying and holding a security like shares, it’s clear that there were few opportunities to produce gains.
First, US utilities: in a year when the US economy is doing well, interest rates are rising and companies were delivering rapid growth in earnings, this would seem hardly a good year to be investing in a very defensive sector like utilities. But the share prices of utilities didn’t fall over the year, and almost all of that return came from dividends. It’s worth noting, UK utilities produced a return of -6.5% in 2018.
Managed healthcare: comprising of only five companies, from the 500 in the S&P index, these healthcare stocks did very well from May to November, but still lost 12% in December.
Short-dated US Treasuries: unsurprisingly, short-dated US bonds (with less than five years to maturity) are very negatively impacted by hikes in interest rates by the Federal Reserve. In the year up to 11th November, these bonds had lost 2.5%. From that date to the end of the year, they returned 3.2%, in response to the sharp sell-off in US equities.
On the short side, Chinese tech was hit by increasing government regulation and the trade war with the US, as was Japanese shipping. Eurozone banks continued to suffer from negative interest rates and poor loan growth, exacerbated by regulatory sanctions; Deutsche Bank’s share price was down 56% last year.
Not surprisingly, the best short of all was in cryptocurrencies. The best performing cryptocurrency was Bitcoin, down 73% in 2018.
The long and the short of it
Given that there wasn’t money to be made being long, but only by being short, why didn’t Nutmeg short some markets?
Put simply, we never go short. There are several reasons for this. From a regulatory perspective, we couldn’t do this for all our customers, and the losses on shorting1 are, in effect, unlimited. Going short would also be prohibitively expensive for niche sectors such as the ones highlighted above. It is also worth noting that equity market-neutral long/short hedge funds – which aim to exploit single-stock opportunities for holding both ‘long’ and ‘short’ positions with the aim of no exposure to the broad moves of stock markets – actually lost 3.5% in 2018.
When very few asset classes produced positive returns, and most sizeable losses, the best investment strategy is to hold a diversified portfolio, and concentrate on the longer term picture for asset class returns, rather than the poor performance of asset class returns in one year.
- Of course, we could buy inverse ETFs, ie. funds that produce the inverse market return of an index, most commonly with a multiple – ie. two times the opposite of the daily performance. But, these funds give you the inverse of the market on a daily basis, not over the long-term. As a result, these don’t provide much use over anything but very short periods (a few days). In short, they are not useful for anything other than short-term speculation.
Performance data: Bloomberg
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.