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On a relative basis, the hedge fund industry performed well in the context of the Q1 2020 volatility caused by the COVID-19 global health crisis. Barclays Strategic Consulting team’s latest survey results convey how investor sentiment has recently changed and how hedge funds may provide protection for investors.

At the beginning of 2020, the team published an outlook study that suggested the global hedge fund industry was entering a new decade with the wind at its back – performance in 2019 was strong, investor sentiment was the best it has been in years and we expected to see marginal, but positive flows into the industry for the first time since 2017.

However, as the COVID-19 pandemic swept the globe within a span of a few months, many countries have effectively been shut down, economic activities ground to a halt and volatility returned to the markets in full force leading central banks around the globe to do what they could to stabilize the economy.

Q1 2020 hedge fund industry performance

While hedge funds were not immune to the sudden downturn, they were able to protect against the downside well relative to the MSCI World. While the MSCI World plunged ~13% in March and 21% through Q1, hedge funds were down roughly 6% in March and only down 8% through Q1. Strategies with higher beta to the equity market were challenged, especially equity long / short and equity event, while discretionary macro and CTA / trend strategies posted positive returns in March, as well as through Q1.

Estimated 2020 Performance by Strategy1
Estimated 2020 Performance by Strategy

1Based on Barclays Capital Solutions estimates

Source: HFR, Barclays Strategic Consulting Analysis

Performance lessons of past crises

Historically, hedge funds have done well in minimizing their downside capture during past crisis periods – both during bull market corrections and during bear markets. When looking at the last three bull market corrections – Eurozone Crisis, ‘15/’16 Correction and 4Q18 Correction – hedge funds only captured about 45-60% of the downside.

Bull Market Corrections
Bull Market Corrections

1HFRX data used instead for HFRI for March 2020 – historically, HFRX has underperformed the HFRI

Source: HFR, Barclays Strategic Consulting analysis 

In each of last two bear markets – Dotcom Bubble and Global Financial Crisis – hedge funds had difficulty coping with the sudden ‘shock month’. Hedge funds adapted well during the remaining months of bear markets, capturing a significantly smaller percentage of the downside. The Dotcom Bubble is noteworthy as hedge funds were virtually immune from the greater market freefall and were down only 2% compared to the roughly 50% drop of the MSCI World. Thus far, in the COVID-19 pandemic, the downside capture has been ~39% for hedge funds, the lowest rate among past crises other than the Dotcom Bubble.

Bear Markets
Bear Markets

1HFRX data used instead for HFRI for March 2020 – historically, HFRX has underperformed the HFRI; 2Shock months are periods where a sudden, unexpected negative event happens; 3Performance of remaining months is the geometric average of returns for months excluding worst performing month(s) 

Source: HFR, Barclays Strategic Consulting analysis 

Investor sentiment and strategy preferences for the rest of 2020

Investors indicated plans to hold more cash compared to their YE 2019 plans as they reassess market conditions for the rest of 2020. On the long-only side, fixed income strategies fell further out of favor, while equity strategies have seen a significant increase, potentially due to investors looking to “buy the dip” of the equity market. Investor sentiment for alternatives, including hedge funds, seems to have faded. While the percentage of investors planning to decrease allocations has remained constant compared to the end of 2019, the percentage of investors planning to increase allocations has effectively halved, in part due to increased difficulty with due diligence. Survey results also show a material reduction in investor sentiment for illiquid alternatives, such as private equity, venture capital and private credit, which has consistently had strong investor interest over the last few years.

% of Investors Planning to Increase / Decrease Allocations in 2020
% of Investors Planning to Increase / Decrease Allocations in 2020

Source: All figures refer to Barclays Strategic Consulting survey results only. Excludes Intermediaries

Survey results also suggest a nuanced picture of investor sentiment and preferences based around whether a strategy relatively outperformed or underperformed expectations. While there are some strategies where the relative performance seems to correlate strongly with investor sentiment, the majority of strategies do not seem to correlate due to various reasons. Tail Risk and Volatility Arbitrage strategies, for example, outperformed relative to expectations, but investors are less likely to allocate due to the nature of these strategies fulfilling an insurance-like role in portfolios, as opposed to generating significant returns. Distressed Credit, Merger Arbitrage and Structured Credit strategies seem to be in favor despite their relative underperformance, as investors look to tactically allocate to these strategies as they hope to capitalize on the dislocation in the market.

While considerable uncertainty remains due to the ongoing COVID-19 pandemic, hedge funds have thus far limited their downside capture relatively effectively. Investor sentiment has turned more defensive in the current environment, which will have downward pressure on industry flows for the near-term, but unlikely to lead to a material exodus of capital from the industry. While we were expecting marginal positive flows for 2020 at the end of 2019, it is now more likely that there will be outflows ranging from $50-100bn. Certain strategies, however, will likely see increased interest as investors adapt and redeploy capital based on where they see opportunities.

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Contact the Strategic Consulting team

If you are interested in reading the full Q1 Review and Current Outlook for the Hedge Fund Industry study, which is available to clients of Barclays Investment Bank, or if you would like to learn more about Strategic Consulting services and reports, please contact strategicconsulting@barclays.com.

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