Study the Process, Not Just the Results

Macro hedge funds came out of the woodwork in January... to brag about their fantastic 2022 gains.

Odey Asset Management, for example, returned a record 152% last year. Like other macro funds, it had bet on rising inflation. And when inflation hurt the bond market, these funds profited big time.

Odey and its peers were quick to highlight their investing acumen. However, since then, they've all mysteriously gone silent...

We haven't heard anything from Odey since it gloated about its great performance last year. And we're not surprised. We warned readers months ago not to get too excited about macro funds' performance.

These bets paid off for the wrong reasons. Hedge funds have been relying on luck for years... and that's not enough in today's market.

As I'll explain today, this tough lesson from the hedge-fund world also applies to stocks. Investors who put short-term performance above long-term strategy are putting their portfolios at risk.  

Funds like Odey had been making the same inflation call for years...

And for years, they were wrong.

Between 2015 and 2020, Odey lost 68%. The S&P 500 was up 82% in that time frame. Odey's gains in 2022 really only recovered its past losses.

Macro hedge funds are getting pummeled this year. London-based Maniyar Capital and New York-based Haidar Capital Management both lost more than 20% in March alone. These macro funds were betting on high inflation and rising interest rates.

Several have even been forced to shut down, especially once the banking sector took a hit. After Silicon Valley Bank collapsed and the bank panic took hold, the odds of another rate hike vanished... and so did these funds' gains.

When institutional investors research a hedge fund, they tend to hyperfocus on the end result. And if they only look at last year's performance for macro funds, they might expect similar performance in the future.

That's where the danger lies.

It's the same with individual investors...

Folks tend to place too much emphasis on what the stock did – if it went up, or down, or traded sideways. And that focus on just the results causes investors to miss the bigger picture.

Of course, plenty of investors get lucky... and plenty of portfolios rise by being in the right stocks at the right time. That's what happened with macro hedge funds in 2022. They got lucky, plain and simple.

It's also what happened with a lot of pandemic-era stocks...

Buy Now, Pay Later ("BNPL") business Affirm (AFRM) is a perfect example. BNPL became a popular business model in 2021.

More folks were shopping online than ever before. They loved the option of paying for expensive items in interest-free installments. And as one of the biggest BNPL companies, Affirm looked like a great investment that year.

The stock went public at $49 per share in January 2021. By November, it had peaked at roughly $168 per share... up more than 240% in less than a year.

Affirm didn't do well because it's a good business. It did well because online shopping took off. Folks were stuck at home with stimulus money to spend.

People came to their senses quickly as we emerged from the pandemic. Today, the stock is sitting around $11 per share...

BNPL became popular at the best possible time for companies like Affirm. Interest rates were basically zero. Folks had a lot of time and money on their hands. And practically nobody was worried about the economy.

All three of those factors have changed since then. Affirm's business model hasn’t adapted. It hasn't proven it can survive in a higher-rate, volatile market.

Like the macro funds, Affirm's success was short-lived. It's down more than 90% from its high. Investors who bet on Affirm in 2021 are in for some pain today.

The best investors understand that process is as important as performance... 

It might even be more critical.

Don't get fooled by one or two great years. If you invest in mutual funds or actively managed exchange-traded funds ("ETFs"), resist the urge to jump into one that's coming off a record year.

A lot of investors got burned by investing in Cathie Wood's ARK Innovation Fund (ARKK) with that very strategy. The fund posted a 143% gain in 2020. Wood poured money into all kinds of high-growth tech companies during what turned out to be a great year for the markets.

ARKK did a great job of marketing its 2020 performance. In January 2021, investors funneled a record $8.2 billion into the fund. It's down 74% since then.

When the market is going strong, nearly everything rises with the tide. Companies without a strong process tend to come crashing down when things turn south.

When you're researching a company or a fund, don't be fooled by rosy short-term gains. Check whether the investment has a long history of success through all kinds of market conditions.

Look for green flags like a history of innovation or a sound business strategy. That's how you can tell an investment has a lasting business model... and isn't only relying on luck.

Regards,

Joel Litman
April 4, 2023

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