Why don’t hedge funds liquidate their positions in a recession?

Prospect in IB-M&A

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.

Comments (23)

  • Investment Manager in HF - Other
Jun 26, 2020

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.

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  • Quant in HF - Other
Jun 27, 2020

This. Liquidity concerns over liquidating a large book aside, the first significant macroeconomic figure that indicated a recession came out in the middle to end of March. If you, as a large asset manager just trading the S&P500, decided to sell knowing there's a recession underway and turned your entire book short, you would have basically sold at the bottom and will now be 25% in the red. Without leverage.

Jun 26, 2020

I don't think that finance is the right career for you buddy - your intuition is interesting to say the least. Who is going to buy all of these positions? aliens?

EDIT: Incredible how sensitive people are on this site. My apologies, everyone is just learning and the market is a very friendly place where everyone has equal opportunity to succeed. There is no such thing as stupid questions kids and no such thing as some people having better intuition on markets than others naturally - make sure to ask all the stupid questions to your PM and then down vote them if they hurt your delicate sensitivities.

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Jun 26, 2020
rumplestiltskin:

I don't think that finance is the right career for you buddy - your intuition is interesting to say the least. Who is going to buy all of these positions? aliens?

The Fed/ECB/BOJ

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Jun 27, 2020

I can't tell if you're serious or not. It almost makes an interesting point but big flaws and you have the wrong order of events. ECB/Fed are massively in the money on their purchases, so it's not like they bailed someone out and took the loss. BOJ I haven't run numbers, but I would guess down in the modern era due to negative rates and emphasis on front end purchases. They are also the only ones buying risk assets rather than just crowding out risk free assets. I would guess they are up on the risk asset portion.

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Funniest
  • Analyst 1 in IB - Ind
Jun 26, 2020

This "hedge fund" dude is probably some robinhood yeet trader don't him seriously

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  • Research Analyst in HF - EquityHedge
Jun 28, 2020

don't hang around the hedge fund forum much do you?

Jun 29, 2020

I think he's a tenured macro trader but I'm not exactly sure what really is the difference between a macro trader that thinks he can read the tea leaves but trades exotic derivatives/curves vs. the random robinhood trader who thinks he can predict tomorrow's SPY barbell graph

Array

Jun 26, 2020

hindsight is 20/20.
many of them have analysts pouring over research endlessly and modeling scenarios. Some holdings might not be liquid enough to unload.
Also they have their own strategy and plan. Funds that have significant scale and strategy are thinking long term.

Jun 27, 2020

This is actually a good question. Some hedge funds do reduce their exposure (both long and short) during prolonged volatile markets. But de-risking when the volatility is up significantly can lead to large price impact on the positions due to lack of liquidity (e.g. selling long positions when the price is already down significantly). By the same reasoning, liquidating the whole book would likely be very costly.

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Jun 28, 2020

Additionally, if it is a MF with a large position and they all of a sudden decide to liquidate, word will get around town that this MF is panic-selling. This causes others to panic sell as well (because they think 'wow they must know something we don't') and herd mentality will take over causing a massive sell-off that tanks the value of the equity, despite being non-reflective of the value of the underlying asset.

Jun 27, 2020

To make this thread educational, when the world changed on that Friday and Monday in March - markets locked up and you were stuck in your positions - even very liquid stuff like USTs until central banks came in.

We are now in a 2008 like scenario where shorts are expensive, crowded, and require a real catalyst to work out - otherwise bleed carry. It's easy to be bearish justike it was into 2008, but you will be surprised how few people actually have big exposure when it works and make the money from it.

Most Helpful
Jun 27, 2020

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.

  1. 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.
  2. 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?

  1. 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.
  2. 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.

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Jun 28, 2020

I agree with this answer, and it's much better said than I could. There's consistently miss information about hedge funds, and often people who work at hedge funds don't even understand what the fund does.

Jun 27, 2020

Sorry if this was mentioned as didn't read the whole thread, but in some (many?) cases (even among HFs) you are paid to manage money, which often precludes you simply going into 100% cash. Some, however are allowed / permitted but even then liquidity will often be an issue even on small books. There's a principle issue of you collecting fees whilst sitting on the sidelines. If so negative why are you not net short (if allowed by mandate)? That's why I find it largely unimpressive that HFs outperform the market when the market crashes - you better when you're not fully net long and your utilization is not at a 100% - rather low bar to clear if you ask me.

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Jun 27, 2020

Phenomenal point. How did I miss this? SB.

OP this is one of the issues in institutional fund management across liquid and illiquid asset classes: mutual funds, hedge funds, Pe funds you name it.

You are paid management fees on committed (but not necessarily invested) capital. Investors HATE it when you sit on cash. The (understandably) figure thatbsince you've pitched yourself as a money making genius, that, well, you should be out making money rather than sitting on the sidelines. Even when stuff is crazy expensive.

Plenty of fund managers will say "wow the market is expensive. I don't like it. But I gotta put this money to work"...

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  • Analyst 3+ in HF - EquityHedge
Jun 27, 2020

To be fair to the original poster, I am going to suggest one case that I have seen plenty of when books are liquidated. And that's in quant books. You can see this looking at latest 13F filings for the quarter. Several quant funds in the small to medium sized range completely liquidated their books at end of March. Now, these liquidations were probably not in anticipation, but rather reactive. They probably ended up losing a lot but at the same time also saved their hides.

A more interesting question as an extension of the original, is when would it be appropriate to deleverage on a book. One idea is that when serial correlation in PnL goes up....

Jun 28, 2020

Just to add on to the above. So for asset management firms, a lot of those managers have mandates for their funds to own majority (usually listed as 80%) in common stock in that M* category/investment style. HFs you are going to see a lot more 13F filings with large put (and options in general) positions.

Moore Capital as an example of this recent downturn had 500,000 SPY put options (their largest position at the time, 5% of their portfolio). This was in their Q4 2019 filing: https://whalewisdom.com/filer/moore-capital-manage...
Big AM firms would never take those kind of positions - and generally are thinking out 10-20 years if not more for their equity positions. Aside from the liquidity information mentioned above, many of the best fund managers actually will add to their positions on these pullbacks (NVDA as an example in end of 2018, AMZN in late March of this year).

Few players recall big pots they have won, strange as it seems, but every player can remember with remarkable accuracy the outstanding tough beats of his career.

Jun 28, 2020

Getting the timing right is hard. If you liquidated last March you missed a pretty big run up.

Another way to think about it: every seller needs a buyer. If everyone is looking to get out, there's nobody on the other side of the trade.

Jun 28, 2020
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Jun 29, 2020
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