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66 Finance & economics The Economist April 25th 2020
2 good returns that are steady and low-risk. became more comfortable with illiquid as-
If hedge funds beat the market during Down, but not out 2 sets. Few will be prepared for a situation in
times of stress, they become a source of Global financial returns, % which the economy is shuttered and pen-
portfolio diversification that is useful to sion contributions and tuition payments
Three months to Twelve months to
endowments and pension schemes. March 31st 2020 March 31st 2020 dry up. Large institutional investors might
By and large, machines have done better face an unprecedented need for cash.
than humans. Around a third of hedge- -20 -15 -10 -5 0 5 It is still too soon to know which funds
fund assets are managed in so-called “sys- Macro funds will navigate the crisis best, let alone how
tematic” funds, which write investment the pandemic will reshape investment de-
Systematic funds
rules based on historical-data analysis and cisions in the longer term. “Returns in
use algorithms to execute trades. On aver- All hedge funds March will end up being just one piece of
age, these have done best: systematic in- Discretionary funds the puzzle,” says Mr Ellis. Many investors
vestors have seen the value of their assets claim they are using the turmoil to make
slip by only 2.1% this year. The Medallion Activist funds long-term bets that may not have lifted re-
fund, the flagship fund run by Renaissance S&P 500 turns yet. But the early signs are that hedge
Technologies and set up by Jim Simons in funds might not come out too badly. The
Sources: Preqin; Bloomberg
1988, was up by 24% in March. By contrast, pendulum seems likely to swing back to-
discretionary funds, which are run by hu- wards holding liquid assets, and hedge
man managers picking and choosing largest lenders admitted to writing down funds appear to be doing well enough that
trades, are down by 12.7%. its private-equity investments by 20% in they might benefit from the reallocation.
Systematic-fund managers offer a few the first quarter. If hedge funds were once a flashy way to
explanations for their better relative per- Another drawback of private equity may generate extra returns for rich individuals,
formance. Carter Lyons of Two Sigma, one prove to be its illiquidity. Pension funds they have since become more pedestrian—
such fund, claims that systematic invest- and university endowments have out- reliable sources of diversification for big
ments have done well because they can goings that are more or less fixed. Stable institutional investors. In turbulent times,
diversify more. “A systematic fund may cash flows in normal times meant that they perhaps that is enough. 7
take several thousand positions, whereas a
discretionary manager may only have 100.” Risk parity
That helps keep systematic portfolios’
losses down when markets are tumbling. Under the weather
Others claim that consistency has helped.
“The great thing about systematic process-
es is that they stick to their knitting,” says How a popular investment strategy unravelled
Luke Ellis, the chief executive of Man
Group, the third-biggest hedge-fund man- he pandemic was a strange beast cording to David Zervos of Jefferies, an
ager in the world. Some of its discretionary “Tthat I didn’t have an edge wrestling investment bank. Risk parity’s out-
funds have done well, but its best perform- with,” says Ray Dalio, founder of Bridge- performance during the global financial
ing ones have been systematic. water Associates, the world’s largest crisis was its making. The average annual
Some bets have come off better than hedge fund, explaining his losses in the return in the s&p risk-parity index in
others. Macro strategies, which place bets first quarter. For years Bridgewater’s 2006-10 was 8%; by contrast, the s&p 500
on economic developments, have fared famed risk-parity strategy produced high equity index made nothing.
best on average, down just 2%. But Bridge- returns for low risk, and was widely At first risk parity fared well during
water Associates, a big macro fund, has adopted by others. But things soured the corona-crisis. Between January 1st
done poorly, brought down by its risk-pari- when covid-19 hit. Mr Dalio reported and March 13th the msci world share-
ty strategy (see box). losses of 7-21% across his funds in the price index fell by 20%. Safe assets were
At the bottom of the heap are activist first quarter, his biggest since late 2008. in high demand. In America the yield on
funds, which buy stakes in companies in Bridgewater created the first risk- the ten-year Treasury, which moves
the hope of changing their strategies or parity portfolio in 1996, when it launched inversely to the price, dipped to a record
management. These were down 16.8% on its All Weather fund. It was intended to low of 0.3% on March 9th. But then bond
average at the end of March. Activists may be insulated from market-wide shocks. A and share prices began to fall in tandem.
have suffered as a result of loading up on typical way to do this is to balance hold- Faced with an intense cash crunch, some
shares at lofty valuations earlier in the year. ings of relatively volatile stocks with investors sold their holdings of even
According to Lazard, an investment bank, government bonds—in times of market liquid assets such as Treasuries. Risk-
activists deployed $2.8bn of capital per stress bonds usually rise in value, off- parity portfolios plunged in value.
week in February. With corporate deals off setting losses from stocks. But that With yields on Treasuries still low,
the table and shareholder meetings post- means less exposure to equities, which proponents of risk parity are on the
poned, they might spy fewer opportunities tend to have higher returns. Bridgewa- lookout for other ways to hedge risk. Mr
to take on company bosses. ter’s innovation was to keep a high allo- Dalio reckons that government borrow-
Varied though their performance has cation of stocks, but to borrow to buy ing undertaken to support the economy
been, hedge funds still look appealing safe long-dated bonds. If the long-dated during the pandemic will stoke inflation,
when compared with many private-equity interest rate is higher than the borrowing making bonds less attractive to hold. Mr
funds. The pandemic seems likely to pose rate, as has generally been the case, this Zervos argues that investment-grade
the most financial danger to highly lever- raises the total return on the portfolio, corporate bonds, which offer a return
aged businesses—precisely the type of firm without adding extra risk. that is around two percentage points
that private-equity funds tend to invest in. The strategy’s success led others to higher than government bonds, could be
Buy-out firms themselves do not disclose follow. Assets allocated to the strategy a substitute. The search for a new way to
returns, but some of their investors—like probably exceeded $1trn in March, ac- outperform begins.
banks—must. This month one of America’s
