Hedge funds face turmoil fueled by virus outbreak
STAMFORD — In recent years, many hedge funds have struggled to match the returns of surging capital markets. But the landscape has changed markedly in the past couple of weeks.
A cornerstone of the state’s financial-services sector, Connecticut hedge funds have watched this week as the stock market has fluctuated wildly in response to the relentless spread of the COVID-19 pandemic across the U.S. and around the world. Having long tried to keep up with a historic bull market, they will now have to show that they can respond effectively to the largest global crisis since the 2008 financial meltdown.
“I think that those with more flexible investment mandates and styles — and the experience and memory of the financial crisis of 2008 — should be better positioned in this market,” said Bruce McGuire, president of the Connecticut Hedge Fund Association. “Just like in 2008, we are witnessing a lot of ‘firsts’ right now, and hedge funds — above all other money managers — are supposed to be able to deal with these events better than most.”
“One hopes this is a short-term blip … but, at this point, we’re just in a period of substantial uncertainty. The financial markets abhor uncertainty.” Lawrence J. White, a professor of economics at New York University
Facing market turmoil
Stocks have plummeted this week, as the coronavirus toll has ballooned to nearly 150,000 cases and more than 5,000 deaths worldwide — including more than 1,200 infections and more than 30 fatalities in the U.S.
On Friday, the Dow Jones Industrial Average staged a rally that sent it nearly 2,000 points higher — its largest-ever point gain — after President Donald Trump declared COVID-19’s spread a national emergency.
A day earlier, the stock market endured its worst slide since the Black Monday crash of 1987.
The S&P 500 plunged 9.5 percent — equal
to a total drop of nearly 27 percent from its all-time high, which was set last month. That drop surpassed the 20 percent threshold for a bear market, ending Wall Street’s unprecedented bull-market run of nearly 11 years.
At the same time, the Dow Jones Industrial Average fell 10 percent, sustaining its heaviest loss since a nearly 23 percent falloff on Oct. 19, 1987.
“A down market is never a good thing for people who are invested in the capital markets nor for the people who manage funds on behalf of the clients who are invested,” said Lawrence J. White, a professor of economics at New York University. “One hopes this is a short-term blip … but, at this point, we’re just in a period of substantial uncertainty. The financial
markets abhor uncertainty.”
Federal interventions so far have included the Federal Reserve announcement Thursday that it would inject up to $1.5 trillion into the financial system and Trump’s announcement Wednesday of month-long restrictions on travel to the U.S. from continental Europe. Last week, the Federal Reserve cut interest rates by half a percentage point.
In a column posted Monday on the Financial Times’ website, Westport-based Bridgewater Associates’ founder and co-chief investment officer, Ray Dalio, predicted the coronavirus would produce a “negative” economic impact that would probably be “big.”
As part of the governmental response to the crisis, he said the Federal Reserve might need to act to hold down interest rates with potential measures such as printing
money and “monetizing” debt.
“While this fiscal-monetary co-ordination is controversial, it is the best policy under the circumstances of the economy now being so indebted and with other forms of stimulation ineffective,” Dalio wrote. “It is also a policy we all need to get used to because it is the only way economic policymakers will be able to deal with economic downturn in this era of near-zero interest rates.”
Ongoing challenges
The post-financial crisis boom has not translated into a halcyon period for the hedge fund industry.
Overall, U.S. hedge funds produced last year an average gain of nearly 13 percent, according to financial-services data firm Preqin. They recorded, on average, a loss of 0.09 percent in 2018 and a return of about 11 percent in 2017.
In comparison, the S&P 500
finished 2019 with a total return, including dividends, of 31.5 percent. The Nasdaq composite grew about 35 percent.
“Generally speaking, hedge funds as a group — which is not always the best way to view them — have complained about the lack of volatility and the fact that one has not been compensated to be ‘hedged’ since this last bull market cycle began,” McGuire said. “So now, they are getting what they have been asking for.”
At Bridgewater, the world’s largest hedge fund by assets under management, the flagship All Weather Fund returned nearly 17 percent in the past year, while another flagship fund, Pure Alpha, was essentially flat.
In 2018, All Weather yielded a loss of about 5 percent and Pure Alpha returned nearly 15 percent.
Steven Cohen’s Stamford-based Point72 Asset Management posted a 13-percent return through the end of last November. It had returned less than 1 percent in 2018.
Uneven returns have contributed to recent layoffs at firms including AQR Capital Management and WorldQuant, which are both based in Greenwich.
But even hedge funds that have prepared for renewed volatility can hardly guarantee a resurgence in their results, according to experts such as White.
“It might just lead people to be wary of being in the stock markets or financial markets more generally,” White said. “What I can imagine is there might be some asset managers, some hedge funds who either were smarter or lucky and come out with smaller losses. I don’t think anybody will be coming out with gains.”