| The December 31, 2018 month-end performance estimate for the Horse Cove Partners Absolute Return Strategy is down (9.38%) net of fees1. Since the December 2010 inception of trading, the Strategy has achieved a total cumulative return of +240.60% net of fees. |
Market Recap and Commentary
S&P 500 Total Return for the month of December was down (9.03%).
The stock markets reversal in the fourth quarter was historic, marking the first time in history that the S&P 500 ended the year negative after being positive for the first three quarters. December was the worst performance for the S&P 500 since the Great Depression. All three major indexes finished the year in the red, and this was the first year over year decline in stocks since 2008.
The S&P 500 was up about 9% through the end of September when an off-handed remark by Federal Chairman Jerome Powell started the selling in October.
The market leaders, FAANG and financials, have begun to deteriorate. China is slowing, as is the US, Europe and just about everyone else. The current administration continues to pursue trade wars, amplifying Chinas already slowing economy which has started to affect U.S. companies (i.e.…AAPL, GM…). The FED has indicated it may slow planned rate hikes but continues to remain committed to reducing its balance sheet. As they continue to drain the extreme excess liquidity from the market, that they have been pumping in since 2008, stocks are expected to get hurt. As rate rise bonds get hurt, as well as real estate and commodities. All of the ingredients are there for a continued slowdown in the economy, and dismal returns for most asset classes in 2019. An extremely ripe environment for HCP Absolute Return.
Performance and Trading Update
Horse Cove Partners Absolute Return Strategy composite was down (9.83%) net of fees in December.
December was a very fittingly wild month to end a wild year. The first few weeks were the worst start to a December since The Great Depression, and obviously posed challenges to our strategy. When we mentioned in last month’s newsletter that we have adjusted our strategy to account for what appears to be a transition to a bear market, we had already taken the losses that account for this down year. In the remainder of the month, we performed quite well and were able to “claw back” some of those losses. At one point in December, the S&P 500 was extremely close to reaching a bear market, down almost 20% from its highs earlier in the year. Not writing calls has allowed us to avoid any trouble as the market rallied into the end of the month - at one point posting the largest one-day rally since 2011.
We strongly believe our adjustments will steer us through this “transition” phase and whether we move into a bear market, or this ends up just being a correction; we expect continued volatility, strong premiums, and a greater potential for outsized returns for the strategy. We continue to keep a close eye on many factors that can affect our trade, and we are always looking for new ways to reduce risk.
Two weeks of losses trading calls (one in January and the other in November) and three weeks in which we closed puts at a loss, pursuant to our risk rules, resulted in our worst year of performance since we began trading the Absolute Return Strategy eight years ago. We are aware that none of our investors have had a down calendar year with us before, and for some, the mark-to-market and performance swings we took this year have caused them to look to our Enhanced Yield strategy.
The bottom line is that we are an options strategy and as such, will be volatile. We faced multiple events this year that statistically should historically be significantly more spread out. Our strategy is based on the assumption that all things eventually revert to the mean, and if that is the case, we would expect a strong period of profitability. While market swings continue to be dramatic, the higher volatility allows us to write significantly further away from the current market and still collect an outsized premium.
We feel the “bear” is now in control of the market. The largest positive moves in the market occur during bear markets, so we remain on the sidelines from selling calls.
Here are the composite net returns for the Portfolio Margin accounts for the periods indicated:
Reg. T Update
Here are the composite net returns for the Reg. T accounts for the periods indicated:
IRA accounts must use Reg. T Margin which means that fewer option contracts may be written than in the “regular” accounts that use Portfolio Margin. Over time, this may also result in lower returns when compared to the “regular” accounts.
HC Enhanced Yield Update
Here are the composite net returns for the Enhanced Yield Strategy for the periods indicated:
IMPORTANT TAX INFORMATION
It has been brought our attention that if you have 2018 net losses on Section 1256 contracts, see IRS Form 6781, the instructions to that form and consult your tax advisor as to the availability of any carryback of such losses to prior years.
We are not in the business of offering tax advice so please consult with your tax professional.
Looking Forward, 2019!
In our opinion, nothing has changed to indicate that our strategy no longer works. The math, the probabilities, and our experience span decades of market activity. It spans all types of economic environments, political environments, and global events. Taking an occasional loss is a fundamental part of our strategy, as it is with any insurance provider, and the key to success is being in the game long enough for the odds to be in your favor.
In 2018, we faced an abrupt transition from the least volatile year in history (2017) to one of the most volatile ever recorded. After a long, unhindered bull market fueled by low rates and unlimited “free” money combined with the lack of healthy corrections stymied by global FED intervention, it appears we may finally be on course to a more “normal” market environment. That being said, many investors today are faced with a troubling landscape: where can we go for return? If rates are rising and the economy is slowing, what will drive their portfolio looking forward?
The volatility spike in February was caused by a liquidity crunch, and an oversaturated short VIX trade blow up that was fueled by record amounts of novice traders in 2x and 3x short VIX ETFs. Most of those players have been wiped out or tamed by regulators now. Without that spike, HCP would have been very close to even for 2018.
We are obviously not transitioning from a low vol year to high one, nor are we facing an extremely overcrowded short VIX trade. We are facing a volatile environment and potential bear markets in stocks, bonds, commodities and real estate. Fear is back in the market and the economy appears to be slowing.
Our strategy works really well most of the time. As with anything, it doesn’t work all of the time. In a year that has seen multiple events that statistically shouldn’t happen so close in time together, it brings to mind the idea of multiple 100-year floods happening in the same year. It’s rare, but it happens.
As mentioned earlier, we have taken steps to recognize the current market environment. By all but eliminating the call trade for the foreseeable future, we can avoid the whipsaw market rallies on little to no news, as the bulls desperately cling to a trading way of life that has persisted for the past 10 years. By artificially inflating VIX, we will be writing further away than typical with significantly stronger probabilities. We strongly believe that these steps will carry our strategy through the current complex environment and on to the next scenario. If we do end up in a bear market, we expect VIX and market premium to remain high, presenting a prime environment for our trade.
We hope that 2019 will be a happy, healthy and prosperous year for you!
About Horse Cove Partners LLC
Profiting from the art and science of taking risk. ®
Horse Cove Partners was founded by Sam DeKinder and Kevin Ellis in January of 2013 with the commitment to help grow client’s assets with a highly disciplined investment strategy, replicated weekly, to extract absolute returns from the market by trading short volatility option spreads. The firm was launched after more than two years of trading experience with personal assets that began in December 2010. The firm is built on the strength of hedge fund trading expertise developed beginning in 2002.
Assets under management at the end of December 2018 were $104.66 million.
“We do not believe we are smarter than the market, nor can we time the market in any given week or month. As a result, we take an investment approach similar to an insurance company in that our investment strategy focuses on the probability of success and the management of risk. We believe that it is possible to realize positive returns through a disciplined focus on the risk of each trade with a weekly investment horizon, and accepting intelligent losses when risk events occur.”
We thank you for your continued support.
Sincerely,
Sam DeKinder, Kevin Ellis
Greg Brennan
Fiona Dyer
John Monahan
Michael Crissey
Don Trotter
sdekinder@horsecovepartners.com
kellis@horsecovepartners.com
gbrennan@horsecovepartners.com
fdyer@horsecovepartners.com
jmonahan@horsecovepartners.com
mcrissey@horsecovepartners.com
dtrotter@horsecovepartners.com
Horse Cove Partners LLC
1899 Powers Ferry RD SE
Suite 120
Atlanta, GA 30339
678-905-5723 main
1Net estimate on a consolidated basis of similar accounts as of 12.31.2018, which is preliminary and subject to revision. Performance estimate described herein as “YTD” are net of fees and expenses including a 2% per year management fee and 20% incentive fee and assumes investors have been invested the entire time with no withdrawals. Individual account returns may vary depending on cash flows, the time period assets are invested, and restrictions placed on the account.
This was prepared by Horse Cove Partners LLC a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Additional information about our firm is also available at www.adviserinfo.sec.gov. You can view the firm’s information on this website by searching by our firm name.
THIS MESSAGE AND ANY FILES TRANSMITTED WITH IT ARE CONFIDENTIAL AND PRIVILEGED. IF YOU ARE NOT THE INTENDED RECIPIENT, PLEASE NOTIFY THE SENDER IMMEDIATELY AT 1 (678) 905 5723. IF YOU ARE NOT THE NAMED ADDRESSEE YOU SHOULD NOT COPY OR DISCLOSE THE CONTENT OF THIS MESSAGE AND ANY FILES TRANSMITTED WITH IT TO ANY OTHER PERSON.
Internet communications are not secure and subject to possible data corruption, either accidentally or on purpose, and may contain viruses. The content of this message should not be construed as investment advice unless explicitly stated as such in the text of this message. Further, this message should not be construed as the solicitation of an offer to purchase or an offer to sell any securities or other financial instruments, including, without limitation, interest in any private investment managed by Horse Cove Partners LLC or any of its affiliated entities.
This material has been prepared solely for informational purposes only. Strategies shown are speculative, involve a high degree of risk and are designed for sophisticated investors.
Past performance is not a guarantee of future results. Investing involves risk, including the possible loss of principal and fluctuation of value. The information herein was obtained from third-party sources. Horse Cove does not guarantee the accuracy or completeness of such information provided by third parties. All information is given as of the date indicated and believed to be reliable. Performance results are estimates pending a verification. The returns are based on the Investment Manager's strategy and the compilation of actual client account trades. The Horse Cove Absolute Return and IRA Return strategies seek to extract absolute returns from the market by trading short volatility option spreads. The Enhanced Yield strategy seeks to achieve a targeted return trading only puts with a high probability of success.
The strategies reflect the deduction of advisory fees and any other expenses that a client would have paid or actually paid. The S&P 500 Index is used for comparative purposes only. The volatility of an index is materially different from that of the model portfolio. The S&P 500 refers to the Standard and Poor's 500 Index which is a capitalization-weighted index of 500 stocks. The index is designed to measure the performance of the broad domestic stock market. The VIX (CBOE volatility index) is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge." Investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Options trading entails a high level of risk. The models do not include the reinvestment of dividends and capital gains because options don't pay dividends. Please read the Characteristics and Risks of Standardized Options available from the Options Clearing Corporation website: http://www.optionsclearing.com for further details.
