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When Preserving Capital Is Wiser Than Growing It

When it comes to investment performance, slow and steady generally wins the race when stretched out over long-term horizons. Even though this practice may not seem glamorous, one hedge fund explained in its year-end letter for 2018 that preserving capital is a wise move during times of extreme volatility.

correlation with the equity
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Maverick preserves capital

In his 2018 letter to investors, Maverick Managing Partner Lee Ainslie said when they wrote their first letter more than 25 years ago, they stated that the fund’s objective was to “preserve and grow capital.” However, “after a bit of debate,” the fund chose to prioritize capital preservation over growth.

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Q4 hedge fund letters, conference, scoops etc

Ainslie noted that the S&P 500 sustained its third-biggest fall in the fund's history in the fourth quarter. He also said that Maverick has managed to outperform the S&P, the MS World Index and the HFRI Equity Hedge Index during times of strong upheaval. He added that Maverick has managed positive returns during times of weakness in the stock markets.

He also reports that the fund performed quite well in January. Maverick was up 6.7% for the month of January. The fund averaged a net exposure of 29%, which was just a bit below their average net exposure of 32% in Q4.

Stocks could be less rewarding from now on

Ainslie warned that the stock markets "are likely to be far less rewarding" in the coming years than they have been in the last few years. As a result, the Maverick team has shifted the fund's exposures down, which means its returns will continue to be driven by alpha generation. He also explained why their focus tends to be more on the fund's long/ short spreads.

"Indeed, both the preservation of capital during the market decline and the growth of capital in the past few weeks were driven by a positive spread between our long and short investments."

Ainslie also noted another benefit of their goal of preserving capital through long/ short spreads. He referenced the fund's low correlation with the equity markets and other long/ short equity funds. He also offered some eye-opening statistics on this. He estimates that Maverick has held a low 2% correlation with the equity markets and 4% correlation with other long/ short equity funds over the last few years.

Low correlations

Interestingly, he estimates that the HFRI's correlation to the equity markets was a much-higher 86%, which he said "makes it clear that the average long/short fund has not produced an uncorrelated return stream." In the long term, he estimates Maverick's correlation with the equity markets at 27% and the HFRI's correlation with the equity markets at 71%.

He also expressed concern that the HFRI has gradually been getting more and more closely correlated with the equity markets. He added that the 86% correlation observed in the last three years is about three times higher than it was 20 years ago.

Ainslie isn't the first to emphasize his fund's low correlation with other benchmarks. Value-oriented Half Moon made similar observations in its recent letter to investors.

This article first appeared on ValueWalk Premium