Volatility as hedge fund friend (and foe)

It perhaps is the role volatility was always meant to play. The driver of subpar returns in an unprecedented market grappling with global economic depression.

It is in front of this backdrop, where a growing number of hedge funds have yet to yield positive gains for the year.

The headlines have shown storied firms such as Renaissance Technologies, which reportedly has lost 21% so far this year through the first week of June. Double-digit losses have led to a significant drop in assets even at the world’s largest hedge fund Bridgewater Associates.

Another storied hedge fund shop, Landsdowne has seen losses in its long/short Landsdowne Princay fund of 41% and nearly 25% losses in its Landsdowne Developed Markets Fund through May, according the HSBC figures. The Tosca Pegasus fund is down 47% through May as well, according to the same report.

When markets were showing little in the way of volatility, marketers blamed the lack of market movement for their underwhelming single digit annual games and now again volatility is bogeyman keeping many a portfolio manager up at night.

According to Societe Generale’s latest hedge fund review, the volatility spike touched off by the global pandemic was a setback to performance.

They based their preliminary data from the Eurekahedge database, which showed that this year to the end of March, the global hedge fund industry’s assets under performance fell by 7.8% year-to-date to $2.1 trillion. The drop in overall performance would appear constrained, but they say the dispersion of individual performance is significant.

In Societe Generale’s June report obtained by Alternatives Watch, researchers said the immediate aftermath of the latest volatility spike has seen bid-offer spreads widen in the volatility space. They said long-term volatility strategies that systematically roll positions can provide interesting alternatives either in equity, rates, FX or commodities.

Meanwhile, interest rates currently remain low even as stock market volatility remains high. But some believe that there are wider trends to watch.

According to Goldman Sachs alum Nancy Davis of Quadratic Capital Management, now is the time to invest in an ETF like hers which seeks to hedge relative interest rate movements whether they are falling or rising. IVOL is up nearly 12% since its launch last May.

At $154 million the IVOL offering has seen its AUM increase by almost 80% in 2020.

“Volatility works both ways,” she added. “It can happen with declines in markets and snapback rallies as we have seen with the pandemic.”

She said that IVOL may work as a potential hedge against the equity losses seen in the first quarter as fixed-income volatility has already returned to pre-COVID crash levels. Equity volatility, she points out, remains elevated and that fixed-income volatility may have something more to offer than moves in equities.

She added that truly uncorrelated assets are very difficult to find, especially during periods of market stress. That fact along with the high fees many hedge fund investors are paying for stock market exposure could be further hampering hedge fund strategies.

Going forward there is still a lot of uncertainty how markets will move and how hedging strategies will be impacted.

“I also expect that the large $3 trillion fiscal spend (equivalent to 14% U.S. GDP) could start pushing inflation expectations higher from the current depressed levels, especially after the jobs number last week,” added Davis. “I also expect the interest rate curve to steepen further as investors become more optimistic in the medium term.”