Tristan Thomas leads the hedge fund investment team at 50 South Capital in Chicago as managing director of portfolio strategy.
A multi-manager hedge fund veteran, Thomas is responsible for portfolio construction and monitoring and is a member of the senior investment committee.
Alternatives Watch caught up with Thomas after one of the most interesting meetings with his investment team, where each member made a compelling case for more capital in each of their underlying strategies. And while the opportunities are many, we discussed what it took to drill down to the right investment at the right time amid a current hedge fund renaissance that seems to be underway.
AW: Looking ahead into 2023, what impact will a probable recession have on hedge fund strategies?
Thomas: It’s probable there will be a recession at this point, certainly outside of the U.S. The UK and Europe overall are already in a recession, while economists have it at 50/50 in the U.S.
The way we set tactical allocations in our portfolio is that we do an offsite meeting three times per year. We just had that meeting Tuesday (Dec. 6). This was one of those uncommon meetings where across the research group, everyone wanted more capital in their strategies. This I think is a good problem. Anytime there is market turbulence, you want it to create winners and losers since both are, of course, key to the success of long/short strategies.
In the environment we are in, manager skill is paramount. But overall, this should be a good environment for long/short strategies and hedge fund strategies in general.
If we see a deeper recession that is more extensive than people are expecting, then we believe we will see an opportunity in distressed credit. Will we get there? I think it is likely, particularly in the UK, whereas in the U.S., it is still a question mark. Next year could be a great year for hedge funds!
AW: What is your prognosis for long/short strategies going forward?
Thomas: Generally, across asset classes, long/short should be interesting. However, we will likely get to a place soon where long/short credit is less interesting due to moves in interest rates.
Long/short equity opportunities abound across the aboard. One thing that has been challenging for long/short equity managers this year is that while there have certainly been winners and losers, it seems to be more sector-based rather than individual companies. I think things get more attractive in the long/short space once you get more dispersion within sectors. At least the way we lean, which is more idiosyncratic bottom-up managers, that is the case.
The other piece to this is rates moving up, which gives a nice tailwind to shorts. You are not starting in the negative when you have a short position on. At worst, you’re neutral or a percent or half percent short interest rebate. Maybe we could get back to the 3-4% rebate that we had prior to the global financial crisis.
On the equity side, we do work with some sector specialists in technology and healthcare. We still prefer small- and mid-cap exposure. We don’t do a lot in U.S. with large caps as we think that market is so efficient that it is hard to generate alpha. It’s hard to pay hedge fund fees to hold Apple and Google, for instance. While still not a lot, we do more large-cap outside of the U.S., where there are still some inefficient markets.
We like the UK and Europe overall a lot, but we have cut back what we’ve done in China. This year has been a turning point somewhat in the ability to invest in China. There we are taking a trading approach rather than a buy and hold one that worked for some time.
AW: What strategies are you watching closely right now?
Thomas: Where our research team spent the better part of 2022 is on credit and distressed credit. The team has been to the UK and continental Europe five times this year. We really think there is a big opportunity in European credit and distressed credit. We have always had exposure to European credit, but we wanted to make sure we had more capacity to deploy capital in this space. We are interested in the U.S. as well, but it has yet to be seen how big the opportunity set gets to be in the U.S. We want to have capacity there as well.
We are always looking for macro managers of high quality. Our allocation is low at the moment, but it has been a great area to generate returns this year and we missed some of that. It is a hard area to discern luck from skill.
Macro is going to be at the top of the list of where people are looking to deploy capital in 2023. You always see interest in macro spike when the world is uncertain. Going back to our tactical allocation meeting on Tuesday, we have our base case, but I can’t remember a time when the band of potential outcomes has been this wide. Perhaps not since the global financial crisis.
You have China reopening, which should normalize supply chains, which is deflationary. On the flip side, a few hundred million people just came out of their homes for the first time in three years – you can argue that is inflationary. Even Powell’s speech last week, if you are bearish, you likely heard rates need to be restrictive for longer. If you are dovish, you heard smaller hikes going forward.
Right now, you must have a lot of humility in forecasting how the world is going to shake out.
AW: In light of so many shifts in the global economy and markets, especially the crypto contagion, how has that impacted portfolio risk management?
Thomas: On the crypto side, I don’t think it has. We intentionally didn’t have any exposure to crypto. We were asked about it a lot when Bitcoin was over $50,000. We found a couple interesting strategies that were arbitraging various exchanges to trade crypto at different levels. But when we took it to our clients, it wasn’t what they wanted. They just wanted long-only crypto exposure and they didn’t know how to do it themselves and were willing to pay hedge fund fees to have help doing it.
We looked at a couple of short trades related to crypto that were interesting. But if they would have worked too well, we were worried we wouldn’t have been paid due to counterparty risk. We missed out on an attractive return on paper, but our concerns proved to be right.
If you look at the industry as a whole you will see some crypto exposure, but my sense is that it doesn’t have a meaningful impact on the industry.
AW: Technology themes are prevalent across the alternative investment landscape? How does technology play a role in how 50 South constructs its portfolio?
Thomas: Massively important. Since the beginning, we have demanded that our hedge fund managers give us full portfolio risk transparency – whether they send it directly to us or to a risk aggregator. We’ve been doing that for over 20 years and what we have been able to do with that data in the last five has been amazing whether it is through off the shelf software or with proprietary systems.
Scenario stress testing and sector detail is done at the manager level, the portfolio level, and then we roll-up the risk data in ways you could never do before. We just hired a full-time coder to our portfolio risk management team. We just got to a point where we needed someone to just code.
We have a million ways to look at the data. But we also need to automate how the data is collected. Then we need to develop better interfaces so the people who don’t live and breathe the data like we do on the portfolio management team, can easily look at it and manipulate it in a way that would be helpful to them.
It is not easy to hire computer science expertise now. It took a while, but we made a great addition to our team in Chicago.
AW: What’s the most recent book you read?
Thomas: Last week I read the parents’ version of “Mental Toughness for Young Athletes: Eight Proven 5-Minute Mindset Exercises for Kids and Teens Who Play Competitive Sports” by Troy Horne. The book was written by a dad whose then 15-year-old son was a highly ranked youth basketball player. I read this since my 13-year-old son is active in a variety of team sports.
A main point of the book is that young athletes, even highly skilled ones, are often scared to make a mistake out of fear of getting taken out of games or letting down their team. They feel they need to be perfect which causes them to play tight and poorly.
At 50 South, we focus on managers early in their lifecycle. It struck me that a lot of what I read in this book is so similar to what we see among a lot of these hedge fund managers when they first launch. It’s not like being number two or three at an established hedge fund is that easy, but there is a difference when your name is on the door. Like young athletes, new managers feel a lot of pressure to be perfect.
Managers will often invest as if they are scared to lose money in their first few months. They don’t trust the process that got them there. If they get out of the gate slowly, they start doubting themselves and they overthink things. We want them to trust their investment process. The process is the only thing that you can control. So often when you see managers that have a bit of trouble, it is because they were unsure or nervous and did something differently than they did before, rather than be confident in their skill and trust their instinct.
