With most global stock indices down between 3 percent and 8 percent on Friday following the Brexit vote, one big outstanding issue is just how prepared were hedge funds for a major selloff.
According to one prime broker, 80 percent of Wall Street was betting on the U.K. remaining in the European Union.
Meanwhile, at the beginning of last week, Bank of America Merrill Lynch reported that leveraged hedge funds were covering shorts and adding to long positions in the Nasdaq 100 and emerging markets. In addition, BofA pointed out in a report that equity long-short funds lifted their net long exposure to 44 percent from 33 percent, above the historical average of 35 percent to 40 percent net long.
However, a report issued by Credit Suisse Group’s Prime Services Group Friday evening pointed out that the majority of funds were defensively positioned with a low gross exposure heading into the Brexit. One exception were the quants, whose gross exposure are near the one-year peak.
However, Credit Suisse also pointed out that a select group of funds increased their net exposure to 23.4 percent through Thursday night from 22.5 percent a week ago, calling it “ill-timed.”
Among specific hedge funds, Daniel Loeb’s Third Point Offshore, which is often characterized as an activist but is closer to a multistrategy fund, cut its gross exposure in its long-short book to around 139 percent by the end of May from 152 percent just the month before. It also significantly reduced its net exposure to about 46 percent from 54 percent. The fund was up 1.2 percent for the year through May after dropping 2.3 percent in the first quarter.
In his first-quarter letter, however, Loeb made clear he was positioning himself to be a buyer. “We are of a contrary view that volatility is bringing excellent opportunities,” he wrote in the report, dated April 26. “We believe that the past few months of increasing complexity are here to stay and now is a more important time than ever to employ active portfolio management to take advantage of this volatility.”
Although he famously asserted at he time that “we are in the first innings of a washout in hedge funds and certain strategies,” Loeb nonetheless stressed that his firm was well-positioned “to seize the opportunities borne out of this chaos,” adding that it preserved capital through the early-year volatility.
Several prominent long-short funds have also indicated that they have reduced their risk and exposure in the past few months.
For example, David Einhorn’s New York-based Greenlight Capital indicated that at the end of May it reduced its gross exposure to 168 percent from 178 percent at the end of the first quarter. However, Greenlight slightly raised its net exposure to 22 percent from 20 percent. Its main hedge funds were up 1.1 percent for the year through May.
Jonathan Auerbach’s Hound Partners Offshore Fund, which was down 12.5 percent through May, has also been reducing its risk. The New York firm typically keeps its gross exposure more or less in the mid-150 percent range. However, at the end of April—the last period Alpha has information for the fund—Hound reduced its net exposure to 26 percent, its lowest level in several years.
Several funds drastically cut their exposure in the first quarter.
For example, Tiger Global Management reduced its gross exposure in its long-short funds to 134.2 percent from about 199 percent at year-end. It also slashed its net exposure to just 5 percent, from 40 percent in December.
The New York firm, founded by Chase Coleman, suffered a 22 percent loss in the first quarter. In its first-quarter letter, Tiger Global blamed mistakes made in its exposure management and stock selection for its first-quarter losses.
The firm said one lesson learned was to “ensure that overall exposure levels are always reflective of the expected returns of the underlying securities in the portfolio.”
Tiger Global gained 1.3 percent in April and 2.3 percent in May, reducing its loss for the year to 18.1 percent.
Meanwhile, at the end of the first quarter, The Passport Global Fund’s gross exposure stood at 176 percent. However, the multistrategy fund’s net exposure was just 18 percent. The fund is managed by John Burbank III’s San Francisco–based Passport Capital.
The fund was down 7.5 percent in the first quarter, primarily due to losses in its short book, and off about 6.2 percent through May.
Then there are funds like Lone Cypress, the flagship long-short fund of Stephen Mandel, Jr.’s Greenwich, Connecticut-based Lone Pine Capital. You won’t see Mandel making big changes to the exposure based on macro views.
Lone Pine typically keeps its gross exposure in the neighborhood of 160 percent, give or take a few percentage points. It also generally maintains a net exposure of around 60 percent, again give or take a few points.
If the market’s Friday selloff persists this week, it will be fascinating to see whether those funds that cut their exposures were able to better weather the storm.
“While equity-based strategies are generally outperforming the broader markets, today’s price action will result in a wide dispersion in June’s performance between and among hedge fund strategies,” noted Friday’s report from Credit Suisse’s Prime Services Group.
