Running a hedge fund is one of the most privileged positions in our capitalist economy. It combines a constantly stimulating intellectual challenge, the potential for significant rewards, and the kind of accountability – in the form of regular, quantifiable measures of performance – that is often missing from the modern workplace.
Running a hedge fund is one of the most privileged positions in our capitalist economy. It combines a constantly stimulating intellectual challenge, the potential for significant rewards, and the kind of accountability – in the form of regular, quantifiable measures of performance – that is often missing from the modern workplace.
At the end of 2018, we were wondering if this was a privilege that we might not deserve.
We had delivered to our investors the worst annual return in our history – and to make matters worse, this was in a year when equity markets saw significant dislocation. We run an absolute return strategy and have always taken our hedging seriously, and despite delivering strong performance in the Global Financial Crisis of 2008 and in the Eurozone crisis in 2011 (and would go on to do so in the 2020 crash and again in Q1 2022), in 2018 this hadn’t worked.
It was a painful experience.
Fund managers often talk about the alignment of interests they have with their LPs, but at Noster Capital this runs deep. In 2018, the partners on the investment team averaged comfortably over 90% of their net worth in the fund (they still do).
But far worse than our personal losses were those we had generated for our investors. We have always been highly selective about the capital we take in, and this meant that the investors for whom we had lost money were not just valued clients, but friends with whom we had close relationships and for whom we had great respect.
Some of our investors withdrew their capital, and for this we do not blame them. Clearly, we were doing something wrong.
At this point, with a reduced management fee base, and a black mark on our track record, the path of least resistance would have been to wind down the fund and raise fresh capital for a new strategy, or even to convert to a family office.
For us, this was never an option.
To those investors who stuck with us, on top of earning back the money that we had lost, we had to vindicate the faith shown in us by fixing what had gone wrong and delivering results good enough not only to restore their capital, but to obviate any opportunity cost that investing with us before 2018 might have created.
Instead of winding down, we cut our already low-cost base to the bone. To keep the team together, we set compensation at well-below market rates. We ceased all marketing activities, reasoning that this would be a distraction when we owed our full attention to our existing investors.
And we took a deep and critical look at what we needed to fix.
This is what we learned:
There is no substitute for experience
Any fund manager will tell you how deeply she cares about client service, how smart her team is, and how much humility she feels in the face of volatile and highly competitive markets.
We said the same before our 2018 experience – and meant it too – but these days we firmly believe that it is only when a fund manager has had these things questioned and put in the hard yards to prove them true that they can truly understand them.
We are far better investors today than we would have been without this experience, and we can think of no possible substitute. Our alertness to risks is sharper, our temperaments are better developed, and our instincts are keener.
It was an expensive education, but it has paid off in returns for our LPs and will continue to do so.
Focus on what you can control
No matter how clever an investor is, or how much she does, some things will always be outside her control.
There is no alpha in complaining. Instead, an investor must focus on a consistent, repeatable process for selecting investments, quality research, humility about what she cannot know, and patience in the face of short-term hurdles.
We can’t say that we watched performance of our portfolio in 2018 with serene grace– but because we had followed our process with discipline, we had confidence to trade rationally.
Since then, these investments have (with a few exceptions) done very well. Focusing on what we could control worked.
Find your edge and dig deep
To generate alpha, an investor needs an edge. We have learned that our best edge is in difficult to understand companies, often in unpopular sectors – and part of our 2018 loss came from straying outside this. Different investors have different niches – often a result of preference, career paths, or simply the availability of opportunities – but when you find one, it pays to dig deep.
Being small is a competitive advantage
After 2018, we found ourselves running a smaller fund than we had before. This taught us the value of being nimble and alert to unexpected opportunities.
First, this meant that we were managing only the ‘stickiest’ capital, belonging only to those investors who had the strongest trust in us, and the longest time horizons, which gave us even more freedom in selecting investments than we had before. This was one of the reasons why we were one of the first hedge funds in London to trade Bitcoin (both on the long and the short side), with great results. Although now that we have a better understanding about this revolutionary idea, we will never short it again.
Second, this gave us the freedom to make investments in unfashionable sectors and smaller market caps that otherwise would have been more difficult to invest in.
We consider it a gift to be a small and nimble fund. In a world of larger and more cumbersome competitors, being able to hunt for returns in all environments is likely to be a sustainable advantage.
Learning these lessons has paid off.
Talking about the S&P 500 might seem slightly odd given that we run a hedged strategy, but as the most frequently cited benchmark in the world, comparisons are difficult to avoid – and in a red-hot bull market beating it is an achievement.
We restructured our portfolio in 2019 in a way that took these lessons to heart – accepting that in a Central Bank driven market, our process would have to reflect this, concentrating our equity investments in places where we could be sure of an edge, and taking advantage of our size and mandate to trade positions in Gold and Bitcoin as part of the portfolio. Since the restructuring, we’ve cumulatively outperformed the S&P 500 by more than 65%. We still do some shorts, but very tactically.
With three years of very solid performance, plus an excellent start to 2022 under our belts (+25% net in the first quarter), we are finally in a position to say that the faith shown in us by our investors has been vindicated, and to reopen our fund to new capital, comfortable in the knowledge that we are doing so as far better investors than we once were. Being shortlisted for a Hedgeweek award is the cherry on top of the cake – and we will try our hardest to be able to win it soon enough.
Pedro de Noronha, Founder and Managing Partner, Noster Capital
Pedro de Noronha is the Founder and Managing Partner of Noster Capital. He began his career in 2000 as an M&A analyst at Merrill Lynch’s London office. He launched Noster Capital in early 2008. A central thesis in this first year of the fund was successfully predicting the 2008 crash. This success was repeated in the chaotic markets of 2011, 2020 and again in 2022.
He manages two strategies; a Long/Short Equity value fund with a macro-overlay, and a systematic strategy designed to capture global market trends and outperform the S&P500.
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