Since the inception of the Flex 9 years ago it has produced a cumulative return of +231% compared to the S&P 500’s +181% during the same period through the end of 2018. Furthermore, a representative hedge fund industry benchmark, the HFRX Equity Hedge Index, has had a cumulative return over that same 9 years of just +2%.
Looking back at 2018
The performance of the Flex in 2018 was a tale of multiple stories. Overall it was somewhat disappointing but nothing we haven’t seen before again and again. For the full year the Flex dropped -14.0% while the S&P 500 was lower by -6.2% (excluding dividends) as illustrated in the below graph.
The following graph shows the difference between the performance of the Flex and the S&P 500 cumulatively throughout the year. At the end of the year, on the far right, it shows the Flex underperforming the S&P 500 by about -8%. Note that this somewhat disappointing 2018 performance followed the Flex’s gain of +39.1% in 2017 when the S&P 500 was up just +21.8%.
As both of the above graphs show, the year started strong fueled by some of 2017’s best performing stocks that continued to surge into the new year. Our long positions consisted of many of these market leaders. The result was the Flex’s best monthly gain since its launch 9 years ago. This January rally quickly reversed with both the Flex and the S&P 500 giving back all of the gains and more and the outperformance of the Flex wiped away.
The market and Flex bounced around from early February through late May when the S&P 500 picked up a little momentum and the Flex did not. The below graph shows that the underperformance of the Flex in 2018 was nearly all concentrated during this less than 3-month period from late May to mid-August. During this period the long positions simply did not add any value while the short positions were moving higher resulting in losses for the Flex.
The graph below shows the performance of both the Flex and S&P 500 from the September 20th peak for the S&P 500 through the end of the year. As you can see in the graph, the Flex generally held up better than the S&P during this decline but not by much of a margin.
Other Period of Underperformance
As mentioned above, the Flex underperforming the S&P 500 in 2018 by -8% is uncommon but certainly has happened before with the most recent being in 2016. The graph below illustrates the cumulative performance difference between the Flex and S&P 500 in 2016. The year started weak with the Flex underperforming the S&P 500 by more than -10% by late April. The gap was closed a couple of times mid-year but the Flex again fell behind with it closing the year underperforming the S&P 500 by -20%. Again, this disappointing 2016 was followed by a very strong 2017 for the Flex as noted above.
Such underperformance also occurred shortly after the launch of the Flex in early 2010. The Flex got off to a strong start outperforming the S&P 500 by +14% in just over 4 months. The tides then turned with the Flex lagging behind the S&P 500 by -29% during the next 9 months…the Flex was down -3% and the S&P 500 was higher by +26% during the period as illustrated in the below graph. It wasn’t until April 2012 that the Flex had caught up and firmly took a lead over the S&P 500. This was a 21-month period when the Flex had lagged behind.
What’s it all mean?
I hate it when the Flex goes down and hate it even more when it underperformers the S&P 500. This is all inconsistent with our long-term goals and expectations. Regardless, I’m not concerned.
Producing above average long-term returns is not easy and will always be accompanied by shorter periods of disappointment and frustration. The Flex has been lagging behind the S&P 500 since May or just under 8 months. To allow this performance over a relatively short period of time, something we’ve documented as uncommon but not entirely out of the ordinary, to negatively impact my expectations would be shortsighted.
Is it over?
There is no way for me to know if the disappointments are behind us at this point. Odds are that such underperformance doesn’t last too long but there have certainly been times when it lasted more than the current 8 months.
Something that has been very consistent about the Flex are short periods of significant outperformance…when the Flex performs meaningfully better than the S&P 500. These have been far more common than the short periods of underperformance.
The accompanying table shows 5 different time periods, all less than 6 months in length, when the Flex outperformed the S&P 500 by 20% - 40% or so. We have every reason to expect such positive bursts in performance in the future.
The Flex has produced great long-term returns since its inception 9 years ago in spite of the various periods of underperformance. I’m total confident it will continue to do so!