High-conviction long bets outperformed high-conviction shorts during Q1 chaos, says MSCI study

Horse racing

High-conviction long-positioned hedge fund portfolios outperformed high-conviction short portfolios during the recent market meltdown, according to new MSCI research exploring how hedge fund managers navigated Q1’s unprecedented volatility surge.

The study, authored by Donald Sze, executive director, MSCI Research and Navneet Kumar, vice president, MSCI Research, examined how hedge funds were positioned in the run up to, and the initial stages of, the Covid-19 crisis.

Noting the key role hedge funds play in global capital markets, the research sought to gauge the changes in portfolios between the end of January and the end of February this year, and how various strategy compositions ultimately performed as coronavirus fears sent global stock markets into a tailspin.

From 1 February up to 31 March, MSCI ACWI Investable Market Index (IMI) collapsed by more than a fifth (21.3 per cent) - with energy and financials particularly hard hit, plummeting 39.4 per cent and 29.7 per cent, respectively.

While market volatility was much higher in March, the MSCI ACWI IMI’s losses were some 11.5 per cent between 18-28 February.

Both information technology and communication services were the two sectors that saw the biggest rise in hedge fund portfolio exposure during February, MSCI’s study found.

Both sectors performed well in March, as the use of digital communication apps and web conferencing technology mushroomed when many countries introduced lockdowns and other social distancing measures.

The study did not detect any major changes to hedge funds’ factor exposure, with managers on aggregate maintaining positive exposure across growth, momentum, volatility and liquidity, and negative exposure to yield, value, size and quality.

As part of the study, MSCI also modelled the performance of a portfolio of high-conviction long bets, and the performance of a similar portfolio of short positions across six conviction metrics. These metrics – including absolute weight, active weight, days to liquidate, and number of owners - aimed to determine the level of conviction in a particular stock within the hedge fund sector.

“When we looked at how these portfolios performed as the market came under significant stress during February and March, we saw that, while their returns were all negative, the high-conviction long portfolios outperformed high-conviction short portfolios for all metrics except ‘days to liquidate’.”