Hedge funds are on track to close out 2017 with a bang. After a three-year drought, hedge funds are finally achieving respectable aggregate gains. Hedge Fund Research reported November’s gains at 0.48 percent, which brings year-to-date gains to 7.56 percent. If the industry can duplicate November’s performance again in December, aggregate hedge fund gains will top 8 percent for the year.
While this is certainly good news for the industry, it must be said that 8 percent gains are not the stuff of legend. For an example of legendary, we turn to Boston-based Whale Rock Capital. This $2.5 billion dollar fund closed out the third quarter of 2017 with an astonishing 30.1 percent gain for its investors.
At this writing, the Senate has passed the Tax Cuts and Jobs Act, 51 to 48, along party lines. The bill passed earlier in the house, but a technical faux pas requires the House to reaffirm their earlier vote. Carried interest survives in the new legislation, which is welcome news for hedge funds and private equity firms.
The Tax Cuts and Jobs Act has the potential to propel the current bull market well into the future. This is a mixed blessing, as hedge funds struggle to achieve gains in such an environment. That said, hedge funds, as evidenced by this year’s performance, have met the challenge and will enjoy the largest performance gains this year since 2013.
One week ago, Janet Yellen raised the Fed Funds rate by 25 basis points in her last hurrah as chair. The FOMC will soon be chaired by Jerome (Jay) Powell, likely to follow in Janet Yellen’s footsteps, but decidedly more pragmatic given his diverse background. How his tenure will play out is uncertain, but many take comfort in the fact that he is not cast in the academic mold.
Most expect modest rate increases and the drawdown of the Fed balance sheet to continue under his leadership. However, if the economy heats up in the wake of the Tax Cuts and Jobs Act, all bets are off.
The best performing strategies are equity related strategies and the concern that many express is that this high percentage of equity investment, the highest in recent memory, makes any hedge fund so invested, extremely vulnerable to market shifts.
If tax reform plays out as predicted by the Trump administration, it is likely to prolong the current bull run. This may result in many more hedge fund firms choosing to pursue equity related strategies and push the percentage of equity investment even higher. This level of equity exposure comes with great risk in the event of unforeseen volatility in the markets. In a bull market environment, long/short strategies are heavily weighted toward long and much less focused on short.
Moreover, the geopolitical forces in play inject yet another element of uncertainty which could impact the markets. Trump’s recognition of Jerusalem as Israel’s capital, the administration’s decision against certifying the Iran nuclear deal, and the inimitable Kim Jong-un represents three such examples of potential international turmoil.