This Is When Hedge Funds Are Supposed to Outperform. Here’s What’s Actually Happening.

“Hedge funds were rolled out as a solution to all the world’s problems, and that obviously isn’t the case,” one consultant said.

(SeongJoon Cho/Bloomberg)

(SeongJoon Cho/Bloomberg)

A worsening outbreak of coronavirus outside of China has sent global equities into a tailspin. The sharp correction in the U.S. and elsewhere is exactly the kind of market conditions that hedge funds are supposed to be built for — so how are they actually doing?

“What you’re going to see is a lot of the directional equity guys are going to get crushed,” Jane Buchan, chief executive and co-chief investment officer of Martlet Asset Management, said by phone Friday. “A lot of them are probably struggling through this.”

Buchan, whose firm Martlet primarily invests in liquid alternatives, added that bond managers “are doing really well” under current market conditions, which have seen equities sell off worldwide. The MSCI World Index, which tracks global equites, dropped more than 9 percent this week through February 27, as the number of coronavirus cases soared in Europe and the Middle East.

In the U.S., the Standard & Poor 500 index fell by almost 11 percent over the same period on growing fears the virus would spread in the country. The Centers for Disease Control and Prevention on February 26 confirmed the first possible instance of community spread of the disease in the U.S. after a person in California contracted coronavirus without relevant travel history or exposure to another known patient.

“You’re not finding a lot of places to hide in terms of geography,” Buchan said. “A lot of the markets are moving very much in tandem so diversifying among strategies is not working very well.”

[II Deep Dive: How Hedge Funds Were Positioned for the Market Selloff]

Equity hedge funds were down 2 percent this year through February 26, according to Hedge Fund Research’s daily performance index. This was better than the MSCI World Index, which fell 4.2 percent over the same period.

“Historically, one of the things that hedge funds have counted is the notion that their returns are less correlated to traditional long-only markets, which is fairly logical,” said Tim Barron, CIO of consulting and outsourced-CIO firm Segal Marco Advisors, in a phone interview Friday. “If you chose wisely and worked with hedge funds that were creating alpha on an absolute return basis, then you could be pretty happy with your hedge fund allocation right now.”

However, he added that it’s “hard to make blanket statements about hedge fund performance,” noting that some managers will be more vulnerable to the ongoing sell-off than others.

“Imagine that you’re a hedge fund who decides the best place to put your assets is on a bet to increased tourism on the part of the Chinese,” he said. “Right now you’d be very unhappy.”

Hedge funds investing in China, where the virus originated in late 2019, were down 3 percent in January, according to HFR. The Shanghai Composite Index, by comparison, fell 2.4 percent in January.

Industry-wide, hedge funds were up by 0.17 percent for the year through February 26, according to HFR’s global hedge fund index. Month-to-date, however, the index has a loss of 0.24 percent. Ken Heinz, president of HFR, said that he expects the next week to be an “interesting” for hedge funds, given speculation around the virus and possible responses by governments and central banks.

“The funds that we talk to, there’s a lot of speculation at this point about whether the central bank will step in,” he said by phone. “Every trader knows that nobody wants to hold positions over the weekend that could look worse with two days of uncertainty. With that being the case, every trader will ask themselves, is that already priced in?”

U.S. equity markets were continuing to sell off Friday, with the S&P 500 down by around 1.5 percent at 1 p.m. in New York. Jim Scheinberg, founder and CIO at North Pier Search Consulting suggested in an email that “panic selling should meet some upside resistance soon” from month-end rebalancing by outsourced CIO firms and target date programs. “Whether this proves to be a market bottom from the correction or just a bounce wall, coronavirus issues continuing to weigh on global equities will remain to be seen,” he said.

How hedge funds perform amidst this volatility will likewise remain to be seen, although Barron said investors shouldn’t expect hedge funds to be a safe haven.

“Hedge funds were rolled out as a solution to all the world’s problems, and that obviously isn’t the case,” he said.