March 2020 was one of the cruelest months ever for global financial markets and not least asset managers trying to navigate the extremely volatile markets. Many were maybe not swimming entirely naked, but when the tide went up last month, a lot of portfolio managers got their clothes ripped off.
We have seen that many asset managers and investment strategies are not performing as expected, both globally and here in the Nordics.
Take hedge funds, which according to HFR were down by more than 10 percent at their worst point during the month of March, but thanks to a strong rebound in risky assets ended the month with a (still sizeable) loss of 6 percent. The equity hedge market lost 10 percent. That’s still better than the losses incurred on the global stock markets, but not if you are supposed to be market neutral.
Casualties are expected
According to Credit Suisse, quantitative driven hedge funds were down by an average of -14 percent as of 29 March. Two Allianz alpha hedge funds were closed according to the Financial Times. If history is any guide, more closures are coming following the market rout, as investors discover that some funds and investment strategies didn’t perform as expected when the going got tough.
The Bridgewater all-weather fund was down by 14 percent at one point in March according to the Wall Street Journal, suggesting the fund offers far from “waterproof” returns and leading the Journal to remark that the fund was apparently in need of an umbrella.
Here in the Nordics, casualties have also emerged. In Denmark, Formuepleje’s ‘Safe’ product had lost more than a third of its value in a month at one point. Not so safe, then – and a much bigger loss than you would expect from a product labeled medium risk.
However, a lot of more “normal” balanced funds have also been severely hit. For example, the Nordea Basic funds, which have lost 5 years of returns in a month. Even the low-risk Basic 1 fund with a benchmark of 85 percent in bonds has seen its returns knocked back to 2015.
History is littered with casualties like these; from the Russian crisis and Long Term Capital management implosion in 1998, the IT bubble in 2000, the Quant Quake and Great Financial Crisis of 2007 and 2008, and now the corona crisis.
Some casualties are expected; for risk premia to exist in financial markets, there must be downturns and violent spikes in return volatility from time to time. It’s part of the game of being in the market.
That being said, very few asset managers had sounded warnings about the extremely high valuations across asset classes like equities, bonds, credit, and alternatives or the extremely compressed risk premia on the fixed income markets before the corona crisis hit in mid-February. Brummer & Partners in Sweden is one notable exception.
Algo traders could be next
Furthermore, many managers have investment strategies, leveraged bets on risk premia, or other forms of quant strategies that only work in particular environments and turn sour when liquidity conditions or correlations change and the macro backdrop adapts.
They thrive in a lowflation or “Goldilocks” environment, i.e. moderate growth, low inflation and high returns on both equities and bonds. That goes for risk parity strategies, but also “normal” balanced 50/50 portfolios and other products.
The bottom line is that many products are far from being all-weather products. If we are lucky and we return to the “lowflation” scenario and our economies soon recover from the corona crisis, these products will bounce back and returns will catch up as they did after the financial crisis in 2009 and 2010.
However, if we’re heading for a stagflationary, inflationary or deflationary scenario for the coming years, which are three scenarios we realistically can’t rule out, then several very common investment strategies, products and algo trades could be in trouble even outside of a recession.
Stress test on product names
Finally, this severe market downturn gives local FSAs and consumer agencies a golden opportunity to go through the different investment products and stress test whether product names are representative of their performance.
In Sweden, Öhman Fonder, the Swedish branch of DNB Bank, and Swedbank Robur have previously been fined and forced to change product names that were deemed misleading.