Resurgence of Equity L/S in 2023
Looking to witness a revival of Equity L/S, whereby fundamental bottom-up stock picking will make a strong comeback when market becomes less 'irrational' than it has been in last couple of years / and this year.
L/S alpha has been sapped due to influx of easy money and thus essentially distorted market into leveraged bet on high-beta and momentum plays.
As we go futher in tightening, market, especially single stocks complex will be more cash generation sensitive.
Anyone share the same outlook?
What exactly is "irrational" about the last couple of years? Fed injects liquidity -> market rips, Fed drains liquidity -> market tanks. Seems perfectly rational to me.
Many "real" L/S funds and particularly market-neutral have thrived during this period.
Maybe you're talking about "closet long" rather than actual L/S investing?
Oh yeah, my comment was including closet long as well. But my main point didn't change.
More specifics on my view on L/S in the past:
My view dated back to post-GFC, whereby if you stick to truly market neutral portfolios, especially during 2012-2019 where everyone saw the alpha decay challenge from that strat.
It's an area where short alpha was extremely scarce, basically fighting FED money pumping which pumped stocks. The advent of passive investing & basket trading also didn't help either because it created more flow inelasticity and drove correlation across the board. Not to mention some idiosyncratic risk from short squeeze/gamma squeeze like we saw in 2021 meme mania. Also, the amount of shops popped up and just did L/S or claimed to do L/S just made the space even more overcrowded.
The L/S funds that delivered returns during secular bull market were actually drift from market neutral and chased high beta like Tiger and ended become more of a levered tech long-only. But then the fact that they weren't market neutral and then ended up getting absolutely wacked when when bull market ended.
Now let's talk about 2022 where I see the irrationality:
Well, actually, it's equities so I always expect some irrational exuberance when it comes to stocks. I'm not talking about tech/growth valuation in past years during secular bulls, valuation is just a function of liquidity and with FED printing.
The irrational part I was mentioning and wanted to emphasize is that the market faith on the FED put, well actually that was crushed last week at Jackson Hole.
I believe market will continue to jump on the 'hopium' a few times more for the rest of the year, and FED will likely drop the hammer again, to teach them 'it's not the FED put, it's the FED short call' and they will be commited to suffocating the upside of market.
On L/S / market neutral performance this year:
Yeah been great but if you pay attention to correlation to this year, when market went through melting up and melting down, internal correlation was consistently strong, which means you don't really have to do much with a beta-neutral portfolio. Everyone talks about 'Oh market tanks correlation goes to 1, and it's bad for portfolios' but actually no, if correlation goes to 1 it's quite easy to handle, when correlation regime shifts from that to something totally different with stocks have unexpected varying degree of correlation is when things get more fascinating.
What I'm seeing for 2023:
Long alpha still remains with strong cash generative assets - well basically it's TIPS but with pricing power during stagflationary period.
But short alpha will be much more interesting, unlike this year where high beta got unwound, there will likely be less correlation to my understanding, I also expect short correlation strat like dispersion could make a comeback as well. Instead of market play like 2022, there will be more sector play and single name play.
And that's basically my humble opinion.