Many hedge fund firms initially underestimated the threat of the coronavirus. Cinctive Capital was not one of them.
Cinctive, founded by Diamondback Capital Management veterans Larry Sapanski and Richard Schimel, launched in September with backing from PAAMCO Launchpad, the joint venture between the Employees Retirement System of Texas and investment firm PAAMCO Prisma to seed and support emerging hedge fund managers. Cinctive, headquartered in New York City’s Hudson Yards, is a long-short equity fund using a multi-manager approach, with numerous investment teams covering roughly half a dozen sectors.
One of those teams — a technology team focused on semiconductors and software — started looking into supply chain disruptions in China early this year. The team talked to factory workers and company managements based in China and shared their findings with Cinctive’s other sector teams.
The semiconductor team was surprised that the U.S. sector wasn’t yet reacting to the coronavirus threat. Around the same time, Cinctive’s health care teams started making calls to virus specialists to understand how the virus was spreading. Alarmed by what they found, Cinctive’s health care team also concluded that the market was discounting the potential impact of the coronavirus.
“People were underestimating the potential magnitude of this, and we were surprised the market wasn’t paying attention to it,” Schimel told Institutional Investor in a phone interview, adding that the market wasn’t pricing in “the severity of the damage that it could do for supply and demand.”
Indeed, the U.S. equity market was surging, hitting its peak on February 20. Fixed-income spreads remained tight, and the chase for yield was in full-swing. But in spite of the euphoria, Cinctive moved quickly to tamp down risks.
The management team had the portfolio managers take a look at what was happening in shorter-term volatility in their books and their stocks, in addition to using their usual risk-modeling tools, to make sure their risk assessments weren’t overlooking what was happening in the moment. The managers then assessed the unintended risks in their portfolios.
Based on what it saw, Cinctive dialed down its use of leverage, or money borrowed to juice returns, with the portfolio managers shrinking the gross exposure from late February through early March. The next step was to monetize the disruption by trading more frequently. The moves paid off: Cinctive returned 4.6 percent through April, compared with a loss of 6.56 percent for the average hedge fund according to data tracker HFR.
In the fourth quarter of last year, the fund lost 2 percent. People close to the firm said that less than 1 percentage point of the loss was due to performance, with the remainder coming from start-up costs, and that the firm hadn’t gotten all of its trading teams up and running by then.
In managing through the first quarter’s chaos, Schimel said that he and Sapanski benefited from their experience at Diamondback, which managed $6 billion at its peak before closing down in 2012. The firm successfully navigated the financial crisis of 2008 by employing a similar playbook: pulling back on leverage after seeing early signs of market instability, which then put the firm in a solid position to take advantage of dislocations in the fourth quarter of that year.
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Looking ahead, Schimel said that in spite of April’s rally — thanks to the U.S. Federal Reserve’s “decisive and quick” actions — the Fed will likely have to do more.
“My view is that the recovery certainly won’t be balanced,” he said. “You have different countries and different states within the U.S. that are coming out of lockdown at different times. It’s going to be tricky and not as balanced or smooth as what the market’s showing.”
Additionally, while the market spiked on positive coronavirus-related news — new cases coming down, states opening up, some positive news on treatments —the timeline for a vaccine remains unclear. Schimel pointed out that the U.S. economy is still driven by consumer demand and said he is concerned that demand may lag after it reopens, as appears to be happening in China.
He said his firm will pay close attention to demand once the economy reopens, focusing particularly on how consumer behavior has changed. Markets tend to look ahead of the economy, he added, and with the travel and restaurant industries basically crimped for the foreseeable future, there will be haves and have-nots.
In the meantime, Cinctive has been busy adding new portfolio managers in spite of the lockdown. The firm has hired five portfolio managers and is in the process of hiring another. It now employs 39 investment professionals, including 17 portfolio managers.
Schimel said now has proved to be a good time to access talent, with some people who had been considering launching their own funds putting those plans on hold, for example.
“We have been able to get great talent during this time,” he said.