Hedge funds caught off guard again in turmoil

Hedge funds have hardly been covering themselves in glory during a tumultuous few weeks for markets.

Sharp moves in the US government bond market and in bank stocks, driven by failures in the US regional banking sector and the fall of Credit Suisse, have left numerous funds in the red for the year.

Many managers were found to be sitting in trades that seemed obvious at the time based on the perfectly rational belief that interest rates had to move higher to combat stubbornly high inflation. Unfortunately, this also meant that these trades became crowded, and therefore dangerous if funds all rushed to the door to reverse them.

Most painful were the bets run by macro and computer-driven funds against government bonds. A number of managers had made a fortune last year latching on to the huge sell-off in bonds and saw little reason to change their view.

But when the collapse of SVB sent investors rushing into the safe haven of government debt and sent the US two-year Treasury yield tumbling at its fastest pace since 1987, funds suddenly found themselves in exactly the wrong position — betting against an asset that investors desperately wanted. Managers racing to unwind their bets only exacerbated the price move.

One of the funds hit hard has been Said Haidar’s Haidar Capital, a standout performer last year when its bond bets helped it make nearly 200 per cent. But it lost 32 per cent from the start of March to the middle of the month, according to people familiar with the data. One of these people said this took losses this year to 44 per cent.

And Chris Rokos’s Rokos Capital, which made more than 50 per cent last year, was also caught out, with the US Securities and Exchange Commission raising concerns after the fund faced margin calls — though counterparties contacted by the FT said they were not concerned about its ability to meet such calls.

Computer-driven hedge funds were also hit. Many that try to profit from following market trends were running short positions in bonds prior to the turmoil and had to quickly cut them. Man Group’s AHL Evolution fund lost 11.3 per cent in March to the 28th of the month, while Progressive Capital Partner’s Tulip Trend dropped 26.3 per cent in March to the 24th.

London-based Aspect Capital slashed its bets on bonds from nearly half of its Diversified fund’s budget for risk in bonds in early March to less than 8 per cent by the end of last week, according to investor documents seen by the Financial Times.

Meanwhile, many funds were also hurt by their bets on bank stocks. In a rising rate environment, owning banks — which would benefit from higher net interest income — seems like a logical move.

Hedge funds’ exposure to the sector duly reached a 12-month high in early February, according to a Morgan Stanley client note, while they ran bets against other parts of the market likely to be hit by higher borrowing costs. That left them badly positioned for the ensuing banking sector shakeout.

Hedge funds were “not bearish the right things” in Europe, said Bernard Ahkong, co-chief investment officer at UBS hedge fund unit O’Connor. It was “a higher interest rate playbook”.

Not every manager was on the wrong side of these moves. Mark Dowding, chief investment officer at RBC BlueBay, had closed his bet against government bonds prior to the turmoil and was then able to put on a short bet following the rally. Roy Niederhoffer’s Macro Diversified fund is up 10.3 per cent in March after benefiting from the market volatility and latching on to the bond rally.

Nevertheless, hedge funds on average have now lost 1.7 per cent in March and are down 0.6 per cent this year up until March 28, according to data group HFR. Not a great look when the S&P 500 equity index was up about 3.4 per cent over the same period.

It marks yet another disappointing episode for the hedge fund industry. After a decade of becalmed markets dominated by central bank stimulus, higher interest rates were meant to usher in a new, more favourable era for managers. Their ability to distinguish winning stocks from losing stocks and to predict major macro trends would supposedly once again pay off.

But the transition to higher rates has also meant a series of landmines and violent market moves that have caught many funds off guard, as discovered by managers holding overpriced technology stocks early last year. Trading conditions may slowly be turning more favourable, but there are likely to be plenty of dangers ahead too.

laurence.fletcher@ft.com