Leading hedge fund managers were caught out by a pause in the swift rise in gold, volatile prices and a resilient stock market in the first quarter.
The correction in the gold price early in 2011 underscored how much many hedge fund managers – including John Paulson and Greenlight Capital’s David Einhorn– relied on gold for their strong performance last year.
All of Greenlight’s funds were down between 2.5 per cent and 3.2 per cent on a net basis in the first quarter.
“While our long [positions] slightly outperformed the market, our shorts rose even more dramatically and our macro hedges were also in the red,” Greenlight wrote in a letter to investors last week. “We had modest losses in our various positions in currencies, interest rates and credit spreads.”
Many investors turned negative on the stock market as macro indicators pointed to a weak economic climate in the US and the Japanese earthquake and nuclear disaster transformed the outlook for energy stocks.
For example, Greenlight, with about $5 billion under management, had short positions on two energy technology shares, assuming earnings would contain negative surprises. But after March 11, investors bought both on the assumption that anything non-nuclear would benefit, the letter said.
In the recent past, funds like Greenlight have been buoyed by rising gold prices.
But for the first quarter, gold prices corrected in January before renewing their upward move later in the period. Mr Einhorn, who is most famous for his bearish views on Lehman Brothers long before its demise, was very early onto the gold trade as a way to express negative sentiment on currencies, most notably the US dollar.
John Paulson, who was also one of the early gold bulls, was also hurt by the pause in gold’s upward trajectory in the first quarter as his gold funds ended the period slightly down, capping a volatile three month ride. The gold funds were down more than 12 per cent in January as the price of gold fell more than $100 that month, then rose more than 13 per cent in February as gold reversed direction and ended March slightly higher than at the beginning of the year.
Meanwhile the $18 billion Paulson Advantage Funds, or so-called event driven strategies, were also down between 1.2 per cent and 1.8 per cent. Mr. Paulson attributed this to the drag on performance from the banking sector “which is still dealing with regulatory uncertainty” in his letter to investors.
Mr Paulson’s strongest performing funds were his $9.3 billion credit funds, which were up between 5.92 per cent and 6.34 per cent in the quarter.
“At a time when other credit managers have large cash positions, or are deploying capital into overheated areas, we have shifted our focus to equity-linked credit investments such as defaulted debt, convertible bonds and post reorganisation equity securities,” the letter to investors said.
Mr Paulson remained optimistic on US prospects and believed the stock market could rally as much as 40 per cent from quarter-end levels, buoyed by strong corporate earnings and price-to-earnings expansion.
“We believe the recovery will likely continue for many more years,” his letter stated.
Mr Einhorn, though, was far more cautious: “In response to quantitative easing, investors now fear inflation and have sold bonds. Interest rates have risen and housing prices have declined further. The housing recovery has faltered, creating another negative wealth effect and putting additional strain on the banking system.”