In March 2020 the average hedge fund has seen an intra-month drawdown of 8.6% to March 20th, according to HFRX data. This is pretty close to the full calendar month loss of 8.7% seen in August 1998, based on HFRI data, which goes back to 1990. This should be seen in the context of global equity markets losing circa 35% over five weeks. Thus, the industry’s beta to equities has been about 0.25, or closer to 0.2 using daily data, according to Ken Heinz of HFR.
Hedge funds have generally offered some degree of diversification by losing less than long only equities, and a handful of hedge fund managers have generated absolute profits. Volatility managers with a long volatility bias and those offering tail risk strategies have sometimes posted extraordinary returns. The CTA industry is starting to show some degree of “crisis alpha”, with strategies run by managers including Campbell & Company, Eckhardt and Systematica putting up particularly strong numbers. Some discretionary commodity traders such as Pierre Andurand, Doug King of The Merchant Commodity Fund, and Stephen Smethurst of Zafiro Capital, have also been well positioned for the collapse in oil prices. In broader discretionary macro strategies, Brevan Howard has also continued its strong performance. In equity long/short, managers who have been bearishly biased for some time, including Crispin Odey and John Horseman, have profited, as have those, including Sandler Asset Management, on the Lyxor platform, who have pivoted to a more tactical short stance.
Where managers have seen a setback, what are their chances of recovering losses and exploiting a new opportunity set? Some arbitrageurs have seen losses on wider spreads, but if merger deals go through to completion at original offer levels, these losses should be recovered. It remains to be seen whether the coronavirus pandemic will be deemed a material adverse change and allow some bidders to renege on deals. Some credit and convertible arbitrage strategies seeing sharp drawdowns could snap back if related instruments re-converge and if their lines of leverage remain intact.
Wider credit spreads now mean that even unleveraged credit strategies could generate quite attractive returns where managers are confident about avoiding defaults. But a wave of defaults could finally unleash the new distressed debt cycle that many managers have been waiting for for some years. Some deals could involve a degree of partnership with governments taking stakes in distressed firms, as was the case in 2008 with the banking sector. Man Group says, “the coronavirus (‘COVID-19’) pandemic has set off a chain of events that, in our view, could lead to the largest global distressed credit cycle in a generation”. This might be focused on travel and tourism sectors, but could also include energy producers reeling from the oil price crash. Distressed investing is well established in the US, but far smaller amounts of capital are chasing opportunities in Europe and emerging markets.
Hedge fund managers with a versatile skill set could generate returns from more idiosyncratic situations, different from the beta-driven markets of the past decade.
Commentary
Issue 147
Editor’s Letter – Issue 147
March 2020
Hamlin Lovell
Originally published in the February | March 2020 issue