Navigating Market Volatility

Market De-risking and Volatility Dynamics

• Hedge fund clients across credit, equity, and systematic strategies significantly de-risked throughout March due to historic market volatility.
• The primary catalyst for position reduction was the breakdown of market correlations, specifically between risk factors like growth versus defensive sectors and borrow factors.
• Clients utilized "crowdedness" metrics (measuring the number of funds holding a position) to identify trading imbalances; the historically stable inverse relationship between popular long and short crowded factors broke down in mid-March.
• Following the breakdown, long factors declined while short factors rose, forcing managers to reduce exposures to reach a level of comfort with increased portfolio volatility.
• As of late March, managers across strategies appear comfortable with their current gross exposure levels, defined at Goldman Sachs as long plus short exposure relative to equity or cash.

Strategic Positioning and Sector Rotation

• Managers are selectively adding to long positions in sectors where they already held overweights, specifically Information Technology and Consumer Discretionary.
• Concurrently, clients are reducing positions in defensive sectors, particularly Utilities and Consumer Staples, which they previously held overweight versus the S&P.
• To manage market risk while increasing single-name exposure, clients are increasingly hedging with macro products, including ETFs and futures.
• The use of ETFs for hedging has accelerated; as a percentage of the overall short book, ETF exposure rose approximately 50% from the beginning of the year to 15% by the end of March.

Performance Metrics and Alpha Generation

• Hedge funds significantly outperformed market indices on a year-to-date basis and successfully preserved capital during the March market downturn.
• Long-short equity clients generated more alpha in Q1 2020 than they did in all of 2019, marking 2019 as the best alpha year since 2013 prior to this period.
• Systematic long-short (quantitative) funds also outperformed indices and maintained downside protection.
• Discretionary macro and multi-strategy funds reportedly fared even better than other categories during the market downdraft.

Investor Sentiment and Forward-Looking Outlook

• Overall sentiment among hedge fund managers and investors is characterized as "constructive and cautiously optimistic."
• Investors, pleased that their portfolios withstood the March volatility, are adopting a proactive stance to deploy capital.
• Capital deployment is focused on two areas: adding capital to previously closed managers and seeking opportunities in dislocated credit and mortgage markets.