Carlson Capital‘s Black Diamond and Double Black Diamond funds managed to do better than the average hedge fund in July, according to investor updates reviewed by ValueWalk. Black Diamond was up .9% in the month and 5.5% for the year, whereas Double Black Diamond gained .8% for the month and 5.35% for the year. Carlson Capital was founded by Clint Carlson and manages over $8 billion in assets across the firm.
Carlson on hedge fund crowding and high beta
Carlson commented on the crowding of hedge funds into a single investment in this recent letter. He said that many hedge funds buying into the same security, even for sound reasons, can jeopardize the investment as the stock then moves more due to their positioning instead of fundamentals. We have seen this phenomenon unfold too many times not to know what Carlson is talking about. Hedge fund gurus have piled into the same investment and gone activist as a group to shake down the company.
Carlson also spoke of the risk of a market sell-off, which could cause an unloading of hedge fund positions in unison. He said that hedge fund portfolios have accumulated beta, and this would cause highly concentrated hedge fund positions to underperform in the event of a market correction. He said that they are trying to circumvent these issues by maintaining low exposure in both credit and equity books. However, preventive measures like these are not always helpful, the letter said:
“Experience, however, tells us that our models probably are underestimating the fund’s exposure to declines in both the equity and credit markets. First, we believe that almost all models systematically underestimate risk. This is mainly because they assume that the future will look like the past, which is seldom the case. The other reason goes back to our concern about hedge fund crowding. Crowded trades tend to have asymmetric or discontinuous betas.”
Carlson said that in order to be more sure of avoiding risk, they could position the portfolio to be net short, which would likely happen if similar market conditions prevail.
Black Diamond funds maintain low net exposure
The Black Diamond funds were up in their equity portfolios and also posted gains in merger arbitrage and special situations. As markets got bumpier in July, the fund hedged its portfolio through puts in the S&P 500. Carlson uses a multi-strategy approach in its hedge funds. We recently reviewed the performance of other multi-strategy hedge funds, and most of them stumbled in July. Take a look here.
The Black Diamond funds were able to post a net gain in their credit portfolio as well, thanks to the rejuvenation of the RMBS market. The funds gained in the non-agency RMBS positions, however, the relative credit value strategy struggled due to a correction in the high yield market. Carlson Capital also has a short position in the euro and in emerging market debt.
According to the latest returns seen by ValueWalk, both Black Diamond and Double Black Diamond retracted in the first week of August.