The hedge fund class of 2020 is more resilient than in 2008
Broader institutional ownership means investors are less likely to bolt
Hedge funds have lost more in the coronavirus sell-off than during the nadir of the 2008 financial crisis. But the near-$3tn industry is unlikely to suffer as many blow-ups this time around.
Hedge funds were down more than 7 per cent on average in March’s market turmoil, according to data group HFR. That was their second-biggest monthly fall on record, beating anything suffered in 2008 or in the eurozone debt crisis a few years later.
Nervy investors pulled $33bn from hedge funds in the first quarter of 2020, or about 1 per cent of total capital, in the biggest quarterly outflow since 2009. But after weeks of rumours of fund collapses, the damage so far has been relatively mild.
“When there are 8,000 funds there will always be a blow-up or two,” said one large asset manager who invests in a range of hedge funds. “But there have been no surprises [in hedge funds], whereas in every other asset class you’ve had surprises.”
One reason: some of the biggest funds have made small losses or even made money. Israel Englander’s Millennium Management, a multi-strategy firm known for a tough approach in cutting dud positions, recovered from small losses in March to finish the first quarter in positive territory.
Paul Singer’s Elliott Management is up around 2 per cent, according to an investor letter, making it one of its best quarters of performance in recent years. The activist investor has been helped by hedges in areas such as stocks and bonds, some of which it sold at a profit.
And macro funds such as Brevan Howard and Caxton Associates have made double-digit gains, helped by the rally in government bonds as investors fled to havens.
There have been some losers. Michael Hintze, founder of CQS, wrote at the turn of the year that he was “cautiously optimistic” and that global growth looked “intact”. That bullishness cost him as his Directional Opportunities fund lost nearly 35 per cent in the first quarter.
Singapore-based Quantedge, one of the world’s top-performing hedge funds last year, fell 29 per cent last month, losing money on its equity, commodity and currency bets. However, clients have been investing a net $10m-$25m per month in the computer-powered fund in recent months, according to its chairman.
And Bruno Crastes’s H2O was hit by wrong-way bets on US Treasuries and Italian bonds, losing more than 50 per cent so far this year in a fund called Allegro and more than 70 per cent in one called Vivace.
But, while it is still early days, the casualty list is far smaller than in 2008 — when nearly 1,500 funds folded, including big names such as Peloton Partners and Highland Capital’s Crusader fund.
Much of this is because a different type of client now invests in hedge funds. In the last financial crisis, many hedge funds were forced sellers of assets because the rich individuals and funds of funds that owned them rushed for the exits — in many cases precipitating the funds’ collapse. Now the dominant investors are institutions, which tend to take much longer to move. Pension funds, endowments, sovereign wealth funds and foundations account for nearly 70 per cent of the investor base, according to the Alternative Investment Management Association.
That stickiness may be showing up in redemptions. March’s $33bn outflow was large, but much less than the $150bn or so yanked in the fourth quarter of 2008.
“It’s a different world [now],” said Cedric Vuignier, head of alternative investments at SYZ Asset Management. “Hedge funds are going to pass through this environment very well.”
One of the things that inflicted most damage on the hedge fund industry last time around, the revelation of Bernard Madoff’s huge fraud in December 2008, has served to protect it this time.
The industry changed almost overnight after funds of hedge funds and private banks, which were supposed to scrutinise managers they invested with, were found to have poured a lot of money into Madoff’s funds. After the Ponzi scheme became clear, investors began doing lengthy due diligence, checking everything from how funds manage risk to where assets are held. Major frauds are now harder to carry out.
And, as HFR’s Ken Heinz points out, three out of the four main hedge fund strategies actually did better in March this year than in October 2008. Only event-driven funds, which bet on mergers and restructurings and which were hurt by fears deals would not close, suffered more.
Moreover, one of the biggest draws for hedge funds is likely to be the lack of attractive opportunities elsewhere. Ten-year bond yields are wafer thin or negative; equities look risky, given the threat to corporate earnings; and with oil turning negative, sending shockwaves through markets, passive funds seem less enticing.
Yes, the industry’s returns in aggregate have been poor in the bull market of the past few years. But now hedge fund managers can claim they look less bad than the other options out there.