Performance results from the first few months of 2020 suggest that defensive strategies have paid off
With performance that significantly trailed the broader market, the hedge fund industry has faced critical questions and attacks for the past decade. But as the coronavirus crisis forces a sudden reckoning for many investment fund products, it seems the long-suffering corner of the alternative investment market is doing better than traditional equities.
“Industry emphasis on capital preservation is currently paying off,” Jeff Willardson, a managing director at Paamco Prisma, told the Wall Street Journal.
Citing data from the Backstop BarclayHedge database, the Journal noted that the US$3-trillion hedge fund industry suffered just 3.04% in losses during the first two months of 2020, while the S&P 500 shed 8.27%. Preliminary first-quarter data up to March from Hedge Fund Research, meanwhile, suggests an average drop of 7% of hedge funds, compared to the approximately 20% loss in the S&P 500.
“Arbitrage … has so far performed well in the beaten-down market,” the Journal noted, citing virtually flat performance for merger arbitrage strategies, a 1.27% rise in fixed-income arbitrage, and 1.41% for convertible arbitrage.
Debt-related funds that include asset-backed loans, credit long-only funds, and mortgage-backed securities have also stayed maintained positive positions. Meanwhile, diversified fixed-income advanced by a modest 1.29%.
While most segments have done well in providing portfolio defence, some strategies have posted declines. That was true particularly for those that were less hedged. Collateralized debt obligations have lost 2.46%. Emerging-markets funds and equity long bias funds, which have seen steadily improving returns over the past five years, have lost 3.81% and 5.57%, respectively, as their largely long exposures left them more vulnerable.
Strategies that have done well so far may not be able to sustain their performance moving forward. Arbitrage strategies, which take advantage of likely price moves between related securities, might face more challenges as extreme market dislocation leads to wider spreads between paired securities.
Asset-backed loans and mortgage-backed securities have been the most consistent performers, delivering single-digit returns over the past five years. But Jonathan Kanterman, a managing director at Stillwater Capital, noted increased risks for structured credit investments such as uncertainty on payment flows from underlying credits, changing valuation of credits, and a possible impact on funds that juice returns using leverage.