News & analysis
HEDGE FUNDS INCREASE THEIR SHORT BETS, BUT GOING LONG PAYS OUT
February and March brought sharp swings in asset prices, mak- ing it a period when hedging strategies were put to the test. The fall in stock markets did indeed lead to a surge in short bets, so how did hedge funds fare in the first round of Covid-19 volatility?
The average figures are not pretty. The Eurekahedge Hedge Fund Index fell by 6.35% throughout March, while assets under management fell $136.2bn (£112bn) due to a combination of poor performance ($94bn/£77.2bn) and net outflows of $42bn (£34.5bn). However, when weighed against the performance of the MSCI World, which has dropped -12.4% year to date, it could be argued that hedge funds did shave off some of the downside risks.
While the lack of portfolio disclosures makes it hard to develop aggregate data on hedge fund strategies and performance, MSCI has made the effort to gain an insight into trading pat- terns, sector preferences and outperforming strategies. It highlighted that, unsurprisingly, hedge funds generally increased their exposure across all sectors in the first three months of 2020 as markets were falling. Throughout February, hedge fund investors stocked up on information technology and communication stocks whilst only
gradually increasing exposure to energy companies. This bet appears to have partially paid off in March as information tech- nology stocks rose against an otherwise falling market. But their increase in shorting has not been well received. By the end of March, UK investors raised their short positions against UK-listed firms to more than 500 a day from a pre-crisis aver- age of 32 positions. This prompted Bank of England governor Andrew Bailey to issue a plea to investors to hold off on short bets. Several European countries, including Italy, Spain, France, Greece and Austria have imposed temporary restrictions on short selling. The FCA said it would not rule out future bans but would set the bar for such restrictions high. Data from the FCA’s register on short positions against UK-listed firms suggests that many of those bets had already preceded the crisis. Firms such as Odey Asset Management, Citadel, AQR and Marshall Wace already held prominent bets against UK-listed firms due to the potential impact of Brexit, from Debenhams to Intu Properties to bets against the Royal Mail and Rolls Royce. But these firms now upped their existing short positions. Yet fund performance data from Morningstar suggests that these short bets don’t always pay off. Marshall Wace’s Market Neutral Ucits fund is down more than 5% YTD, while Crispin Odey’s Swan Fund rose by more than 18% in the year to March, while by the end of that month, performance fell to 5%.
EMERGING MARKET DEBT INVESTORS FACING WRITE-OFF PRESSURE
With global commodity prices plunging and economic growth contracting, emerging and frontier markets are on the brink of yet another sovereign debt crisis, the IMF has warned. Fuelled by central bank interventions and investors’ demand for higher returns, the emerging market debt universe has increased rapidly in recent years. The market is now worth $71trn (£58.3bn), according to the Institute for International Finance (IIF) with the ratio of emerging market corporate and sovereign debt to GDP standing at 180%, compared to almost 130% during the 2008 crisis. Enter Covid-19 and things turned sour quickly. The IMF has re-adjusted its growth outlook for emerging markets to -1%, compared to its prediction of +4.6% at the end of last year. In the first quarter of 2020, emerging markets faced unprece- dented levels of capital flight, with outflows approaching $100bn (£82bn), nearly three times the levels recorded in 2008, the IIF says. European investors withdrew some €9.3bn (£8.2bn) from emerging market hard currency funds in the first quarter, according to Lipper.
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While developed markets have also seen surging debt levels, the concern is that crippling interest payments and plunging currency values could accelerate the speed of the crisis, a pat- tern all too familiar for many emerging countries. This is aggravated by the fact that the majority of global debt is now issued in local currency.
Inflation in major emerging market economies, such as South Africa, Brazil and Mexico, is now hovering around 20%. And this time, struggles to repay debt could also hamper their abil- ity to respond to Covid-19, sparking yet another vicious cycle. Following public pressure from NGOs and governments, the IMF announced in April the suspension of $215m (£177.5m) of debt for the poorest frontier markets, including Sierra Leone and Liberia. As of May 2020, more than 100 countries have appealed for IMF support to deal with the crisis. But the Jubilee Debt Campaign, a charity which advocates the cancellation of third world debt, estimates that some $300bn (£247.7bn) in debt cancellations over the next year would be required to help emerging and frontier markets tackle the effects of Covid-19. As a result, pressure is growing on private investors to write-off some of their emerging market debt assets, Jubilee says.
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