Will A Wave Of Hedge Fund Redemptions Cause A ‘Double Dip’ For Stocks?

Will a wave of hedge fund redemptions cause a “double dip” for an equity market coming off its worst quarter since 2008?

JPMorgan doesn’t think so.

“The panicky selling of all types of funds by retail investors for two consecutive weeks is raising questions about potential redemptions by hedge funds”, the bank’s Nikolaos Panigirtzoglou says, in the course of reminding you that “during the Lehman crisis, unprecedented HF redemptions played a big role in propagating the equity and credit market falls up until the first quarter of 2009, perhaps being responsible for the double dip in March”.

Fear not, though. According to what Panigirtzoglou describes as “anecdotal evidence” from the bank’s prime business, as well as investors and fund admins, it doesn’t seem like a “redemption wave” is in the cards.

Obviously, redemptions are tied to underperformance and looking at a broad gauge of daily reporting funds, losses haven’t been that steep, all things considered. I’m using a simple chart of the HFRX Global Hedge Fund Index below – it’s designed to be representative of the overall composition of the hedge fund universe.

“The combined HF performance during February and March looks overall better than in 2008”, Panigirtzoglou goes on to write, comparing the last two months to September and October during the GFC (so, in and around Lehman). Again, I’m using monthly data from HFR for the chart.

Panigirtzoglou also says performance distribution is probably better now than in 2008. He cites double-digit losses for risk parity and relative value funds, but notes that “traditional trend following CTAs and traditional macro hedge funds appeared to have done a lot better”.

Further, he points to “significantly lower leverage”, as measured by the ratio of fund return volatility to the volatility of the asset traded. On that score, leverage is lower than pre-Lehman levels.

(JPMorgan)

To drive the point home, Panigirtzoglou flags a steady decline in the share of funds-of-funds “in favor of long-term oriented investors such as pension funds, insurance companies and endowments”. In terms of total hedge fund AUM, funds-of-funds’ share has been cut in half, dropping from north of 40% in 2008 to roughly 20% now.

The takeaway, for JPMorgan anyway, is that generally speaking, “the risk of a wave of heavy HF redemptions causing a double dip in equity markets similar to March 2009 is low in the current conjuncture”.

Of course, that doesn’t rule out a double dip. Rather, it just means that the evolution of the virus and market participants’ reaction to the news flow going forward would likely be the catalyst, not the knock-on effects of HF redemptions.

For the past two weeks, the financial media has been keen to document the fortunes (and misfortunes) of various funds and managers, both “name brand” and otherwise.

Bridgwater’s Pure Alpha II was down around 13% in March through mid-month, for example, bringing its total loss for the year to around 20%. Ray Dalio lamented the underperformance. “We did not know how to navigate the virus and chose not to because we didn’t think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk”, Dalio told FT this month.

By contrast, the Brevan Howard Master Fund was up some 17% in the three weeks through March 20, on pace for its best gain ever, and bringing its YTD gain to nearly 22%, according to an investor letter.

These really are apples to oranges comparisons, but it’s still fun to chart them.

Boaz Weinstein, meanwhile, was up more than 80% in Q1 through March 20 thanks in part to CDS bets, some of which had already resulted in YTD returns in excess of 25% headed into this month. Late last year, Saba bought swaps on cruise operators and airlines, according to sources.

And then there’s tail fund 36 South Capital Advisors LLP, which had its best month since 2008 in February, and predicted “the strongest performance is likely ahead of us”, in an interview with Bloomberg on March 6.

Finally, there’s the story of Zhou Wang, whose fund QQQ Capital ramped up bets against airlines and hotels while simultaneously shorting the S&P sometime around the turn of the year, in a gamble that the pandemic would get worse.

While the first three weeks of January were rough for Wang, his Singapore-based fund surged nearly 80% as global markets tumbled. “Now QQQ is betting the market sell-off has been overdone, taking profit from its shorts as it prepares for the possibility of central banks releasing additional liquidity or cutting interest rates further to help economies rebound”, Bloomberg wrote, on March 8. Given what’s happened since then, one hopes, for Wang’s sake anyway, that QQQ held onto at least some of those short bets.

Oh, and David Einhorn was down 12% in March, according to headlines on Tuesday evening.