Why don’t hedge funds liquidate their positions in a recession?
Hi all,
Pretty open ended question, and im obviously uninformed
But I was curious as to why hedge funds or large asset managers don’t liquidate their positions when they know a recession is about to happen, or convert to mostly shorts?
I have heard of hedge funds maintaining a neutral position in which they have the same amounts of longs and shorts but is that common or required?
And while i understand that many hedge funds shine during recessions im also wondering why that it is, or why others asset managers don’t liquidate or short in similar instances?
Is it because their positions are too large to do that without causing unnecessary damage?
Obviously have a lot of questions, and would appreciate as much insight or understanding any of you could offer as to the workings and strategies of hedge funds and other managers.
I don’t mean this to be harsh, but you are asking why hedge funds can’t see into the future.
If you think there is a recession that doesn’t necessarily mean you think markets will tank. If you think markets will tank, then sure you short positions, but how do you know that? It’s the same as knowing/thinking markets will rise. How do you know this? If you know the way the market will move you take that position (accounting for risk and managing that) but you are never sure, what makes you think HFs know where markets are headed? I’m not sure I understand your question.
OP ignore some of the garbage that people throw at you (why the hate, I don't know)... It's ok to ask such questions since, well, you are a prospect, and because an alarming number of people in the hedge fund industry seem to make lots of money for themselves by, like, not making much money for investors and then blowing up when times get tough.
Like the poster below you said, HFs have no better ability to predict recession/bear markets better than the average person. Plenty of people predicted the housing crisis and positioned for it... A few years too early. Those hedges/positions BLEED money. So if the market is ripping up and you are hedged, well, you either aren't making any money or aren't making enough money. Your investors keep looking at their monthly statements you send them and think "We are paying this muppet to not make money in a hot market? Let's take our money out..." So in order to keep your investors happy and yourself profitable, you either have to take the hedges off and join the crowd of bulls, keep said hedges light, or find other parts of the book to really outperform (this is not easy either..) to cover the cost of the hedges and more.
Markets and GDP growth don't necessarily correlate. Markets are forward looking and economic data is backwards looking. So the genius economists will tell you that we have been in a recession, since well, whenever, like 3-6-12 months after the fact. Currently (at least in the US), we are in a recession. Unemployment is at like 13%. You saw what happened in March. But look at where the stock market is today (yes markets are more than just stocks, there are bonds, rates, fx, commodities blah blah).
Close your eyes for a second and imagine that I came to you on January 1st... What if I was to tell you that in 6 months from now, that there would be a global pandemic that killed a bunch of people, literally shut down entire economies, had Trump and gang GIVING OUT MONEY to people, 10Y treasuries trading down to 60/70 bps (down from like 1.8%), unemployment would be well over 10%... And asked you to guess what the S&P would be... Would you guess (as of today), that the S&P would only be down like 7%? I know I wouldn't....
Yes plenty of hedge funds are neutral. Kind of. You could be long Ford stock and short GM, or something like that, but there is idiosyncratic risk, right? Like Ford could perform worse than GM and you could lose money, right? After all, if you are PERFECTLY hedged, in theory it should be impossible to lose money, right? In the same way, it should be impossible to make money as well. And if that's the case, why not just be in cash and do something else with your life instead of staring at screens 18 hours a day?
SOME hedge funds shine during recession. Many blow up spectacularly because they are over-levered, too long, gamblers in very thin disguise etc etc. Others survive to see another day.
Many managers do liquidate in down markets, however, it is not necessarily to reload and buy low (as another poster kind of alluded to). More often managers need to sell, because, well, their investors WANT OUT.
Say you are an "asset manager" (ie. a mutual fund), one of your big clients calls you up and says "Hey buddy, our portfolio is unbalanced, or I need to shift things, or I need cash", well you need to redeem that client and give him/her CASH. That means you gotta sell. So as the market violently sells off (others are also rushing to cash, since they have clients who want cash as well, others are shorting, and you join the party), and the selling gets more and more severe. Remember it's not just humans pushing buttons anymore.. You have HFT and quant shops trading size as well. Things today move in bigger size and much faster than ever before. Also most mutual funds can't short. It's not in their mandate to do so.
Positions being too large? There are certainly plenty of funds that have those...
Apologies for the long post but I hope this helps.
Also, OP - I can't help myself.
Do not underestimate the power of crowding of markets/certain trades. The amount of original thought, especially in the larger trades across asset classes, is scant. Maybe one guy gets an idea and puts it on in SIZE. Or he sits at some dinner with Powell/Bernanke/Zuck etc with his buddies/rivals at Le Bernardin... Everyone talks, things are disclosed, some markets are illiquid and so the moves in securities are noticeable by many participants and people chase (trades, performance etc). This is what happens when many people have broadly similar educational backgrounds/go to the same country clubs/gyms and chase the same pool of capital (ie. LPs).
Chasing trades is not limited to HFs/MFs. You'll see PE funds chasing the same deals, bidding against each other, teaming up, or chasing something in a similar space. Often they all have the same or very similar thesis. All of that is fine in a bull market when the rising tide lifts all boats, but in volatile or bear markets...
LPs are the same too. CPPIB or Yale is in something in size, especially early on or for a first close? The money from others floods in and diligence can be cursory, after all, the "smart and connected" money is in... Can't get fired for following them. Then the other smaller fish come to bite since all of the big money comes in and surely this must be a good thing.
The truth is, really good ideas that are scalable either get crowded and levered quick, or have plenty of people going the other way... Other genius ideas are not too scalable, so one can generate great numbers... But then they have all this capital (from returns or more LPs) than they know what to do with. Then comes the temptation.... Do I knowingly keep the money and clip 2% and hope to get lucky for a few years to clip that 15/20 performance fee (while clipping 2 on an enlarged base)... or do I return the money to clients saying, "Hey I have too much money to be really good here, so have decided to give back money."
I'll give you a hint... Most choose the former. And those doing the latter, usually do so after a few subpar years of underperformance...
I'll stop here.