Financial Times Europe 27Mar2020

8 ★ FINANCIAL TIMES Friday27 March 2020

COMPANIES

R O B I N W I G G L E SWO RT H , L AU R E N C E
F L E TC H E R A N D O RT E N CA A L I A J

Earlier this year, Ray Dalio, the hedge
fund magnate, admitted that he and his
team at Bridgewater Associates were
“dumb shits” when it came to pandem-
ics. The best they could do was to ride
straight through the coronavirus-
triggered market turbulence.
“It would be a mistake to whipsaw
ourselves by overriding our process to
react to the most recent headlines,”
Bridgewater told investors in February.
A month later, Bridgewater’s flagship
Pure Alpha hedge fund was nursing
a 14 per cent loss for the year to March
18, and a more aggressive version of the
fund was down 21 per cent. Mr Dalio
admitted that — despite a carefully nur-
tured image as an economic soothsayer
— he had simply got it wrong.
“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,” he
said at the time. “So we stayed in our
positions and in retrospect we should
have cut all risk.”
The hedge fund industry’s pitch is
that it aims to make money in most
market conditions and protect inves-
tors’ capital in a downturn. This was
called into question during the 2008
financial crisis when the average hedge
fund lost 18 per cent — substantially bet-
ter than equity markets — but a big drop
nonetheless.
In the decade since then the industry
overall has put in alacklustre perform-
ance. Record-low interest rates and a
multiyear bull market induced by cen-
tral banks pumping money into the sys-
tem have favoured cheap index-track-
ing funds.
For years, hedge fund managers have
craved more volatility. The industry’s
proponents predicted it would prove its
mettle with renewed turbulence. In

spite of the grim reasons for the prevail-
ing market chaos and the human and
economic toll the pandemic is exacting
— those seeking more volatility now
have their wish.
Initially the hedge fund industry as
a whole fared fairly well during the tur-
bulence. The average hedge fund lost
1.4 per cent in February, according to
HFR, even though markets whipsawed.
But the early resilience faded asturmoil
deepened, blowing up even previously
reliable trades. Hedge funds aredown
8.6 per cent in March, and nearly 10 per
cent for the year, HFR said.
This setback comes at a precarious
time. Hedge funds have already suffered

investor outflows for 13 of the past

17 quarters — with buoyant markets

helping keep the industry’s assets under

management steady at about $3tn —

and the number of firms has shrunk for

five consecutive years.

Many of those that remain are less

profitable. A spell of disappointing

returns hasmade the 2 per cent man-

agement fee and 20 per cent perform-

ance fee structure the exception rather

than the rule.

The turmoil provides an opportunity

— and for many managers, a last chance

— to prove their worth, say investors

and industry insiders. But many fear it

is most likely to bring a 2008-style mass

cull of hedge funds — with smaller ones

particularly vulnerable — and reshape it

in profound ways.

“What is happening now is epic,” said

Mark Connors, a former hedge fund

manager who now works on Credit

Suisse’s prime brokerage desk. “The

industry will not be the same after this,”

he added, predicting that many funds

will fall by the wayside, while the big will

become bigger.

There have already been casualties,

such asMalachite Capital Management;

and someManikay Partners unds aref

returning capital to investors. Many

others are nursing their biggest losses

since the 2008 crisis and are flummoxed

by the day-to-day challenges of trying to

navigate the markets.

“It feels like strapping on a flak jacket

and jumping on hand grenades going off

every day,” said the head of one US

hedge fund. “And it feels like I’ve lost

some body parts.”

In their moment of reckoning, hedge

funds are facing constraints on their

style of investing as some European

countries ban short selling, the practice

of betting on falling prices.

“You can’t blame short sellers just

because some industries [or] compa-

nies are doing very badly these days,”

said Lionel Melka, fund manager at

HOMA Capital. “Throwing the ther-

mometer in the bin does not decrease

your fever.”

There has been a wide dispersion in

performance across hedge fund strate-

gies, between individual managers, and

even within multi-strategy funds. Most

strategies have suffered at least one

stretch of stomach-churning losses.

Two weeks ago, hedge funds that seek

to profit from slight discrepancies

between almost identical US Treasuries,

or Treasury bonds and Treasury

futures, were hammered when these

spreads widened instead of narrowed,

threatening to set off an avalanche of

failures.

The strategy is popular because

of its usual steadiness, and as a result

of that, firms use heaps of leverage to

boost returns. However, when the

normal correlations break down and

all assets sell off together — as they

did two weeks ago — things can quickly

turn ugly.

Fund managers said that the Federal

Reserve’s aggressive monetary easing

has stanched the bleeding, but not

before some of thebiggest names got

hit, including Citadel and Millennium

Management. More recently, the pain

has been acute among traditional long/

short equity hedge funds that buy and

sell stocks have also suffered.

Last week it constituted a “hedge fund

deleveraging Armageddon”, according

to Yin Luo of Wolfe Research. Event-

driven funds that tradecompany merg-

ers ere also among the victims.w

Quantitative managers that use com-

puters to capture market trends have

also disappointed. Trend-following

strategies gained 18 per cent in 2008 but

have largely struggled since then. If they

do not prove their worth now, “there is

no reason for them to survive”, said one

big investor.

On the other hand, some global macro

funds, which make bets on big economic

trends, have managed to profit from the

recent bout of volatility more than

most. Brevan Howard Asset Manage-

ment and Caxton Associates have

chalked up double-digit gains this year

thanks to bets on rising bond prices,

according to investors.

Given the turbulent markets, many

investors will be evaluating their hedge

fund allocations, and the result is likely

to be more outflows.

Simon Lack, a hedge fund allocator at

JPMorgan turned critic of the industry,

said: “If they just lose a bit less than

stocks, then I think a lot of investors will

ask, what is the point?”

Virus delivers shock to hedge fund sector

Managers’ ability to weather all conditions was called into question in 2008 and is being put to the test once more

Sector under pressure

Performance ()

- - - 

Hedge fund industry

Equity hedge funds

Market-neutral funds

Merger arbitrage

Global macro

Relative value arbitrage

Emerging markets

Credit hedge funds

Source: Hedge Fund Research

March

Year to date

Return index













     

HFRI

Vanguard Balanced Fund index

Number of hedge funds globally (’)













    

Funds have fallen

for five consecutive years

Industry

participants

who had been

yearning for

greater

volatility are

having to deal

with what they

wanted

‘What is happening

now is epic. The industry

will not be the same

after this’

‘It feels like strapping on

a flak jacket and jumping

on hand grenades going

off every day’

14 %

Loss sustained by

Pure Alpha hedge

fund for the year

to March 18

18 %

Hit to the average

hedge fund during

the 2008 financial

crisis

N I C H O L A S M E GAW A N D P H I L I P STA F FO R D

LO N D O N

Dutch lender ABN Amro will take a

$200m hit to its profits aftermarket

turmoil left the bank on the hook when

a customer was unable to stump up

extra money needed to keep trading.

The customer, which ABN did not iden-

tify, had been unable to meet margin

calls required to keep trading US futures

and options amid the wild swings of

recent weeks.

ABN, which remains majority-owned

by the Dutch government, said hat itt

had been forced to close out the posi-

tions of the customer and saddled with

the loss. The loss is equivalent to almost

10 per cent of the bank’s annual profits.

The disclosure sent shares in ABN

down 5 per cent in early afternoon trad-

ing, worse than the 2 per cent drop in

Europe’s broader Stoxx 600 index. The

trading loss, which came in ABN’s clear-

ing arm, is one of the biggest hits yet to a

bank from theturbulence unleashed by

the coronavirus outbreak.

ABN’s clearing arm earns much of its

profits sitting between exchanges and

clearing houses, charging customers a

fee to provide the capital that traders

are obliged to set aside if their bets sour.

But banks are left exposed if a customer

can no longer meet the demands from

the clearing house to settle failed trades.

The Dutch bank’s clearing arm proc-

esses more than 20m securities and

derivatives deals per day for customers

including high-frequency traders and

market makers, many of which are

based in the Netherlands and Chicago.

The market mayhem has already

inflicted losses on some trading firms.

Last week Ronin Capital, a Chicago-

based proprietary trader, collapsed

after it was unable to meet margin calls

on its futures and bond trades. Its main

clearing house, the CME Group, said it

had auctioned off Ronin’s portfolios.

The intense volatility, which has seen

closely watched benchmarks such as

the Vix volatility index suddenly rise,

has also hurt the ability of proprietary

traders, or those firms trading with their

own money, to operate.

ABN, which has been majority owned

by the Dutch state since its bailout dur-

ing the 2008-09 financial crisis, had

already been under pressure from the

start of the virus pandemic because of

its heavy exposure to the energy sector.

In February, it announced a second

review of its corporate and investment

banking business in as many years. It

had suffered a sharp increase in bad

debts among customers in the offshore

oil and gas sector, even before the recent

collapse in crude prices.

Traders have in recent weeks urged

regulators to loosen rules around

options trading in light of the recent vol-

atility, arguing that they can suddenly

be left with having to stump up much

more money when the notional value of

options decline. On Monday, industry

group FIA Epta warned that some trad-

ers could pull back from markets as a

result.

Banks

ABN takes $200m hit after

stumping up for client’s loss

The market mayhem has

inflicted losses — Ronin

Capital, a proprietary

trader, collapsed last week

MARCH 27 2020 Section:Companies Time: 3/202026/ - 18:24 User:cathy.pryor Page Name:CONEWS2, Part,Page,Edition:EUR , 8, 1