While short-selling outperformed other hedge fund strategies throughout February, 10 out of 13 strategies posted negative returns, Edhec-Risk found.
The global think tank for investment solutions analysed the performance of different hedge fund strategies by using its ‘Edhec-Risk Alternative Indices’.
As indices are heterogenous, making it difficult to assess hedge fund performance, it created ‘index of indexes’, which it said aim to reflect significantly higher degrees of representativity and stability than available indexes on the market.
Edhec-Risk Alternative Indices are able to capture a very large fraction of the information contained in the competing indexes, it said.
Historical returns show similar trend
Short selling performed well above its long-term average performance in February, with 2.96%, and was followed by convertible arbitrage (0.80%) (see table below).
Véronique Le Sourd (pictured), senior research engineer at Edhec-Risk Institute, said that the strategy achieves its best performance in a context of declining markets.
In February, the S&P 500 Index registered a severe decline (-8.23%), its biggest drop in a month since December 2018.
Volatility jumped from 18.84% to 40.11% in a month, reaching double its historical mean value and its highest level since September 2011, said Edhec-Risk.
Commenting on the historic performance of the Edhec hedge fund indices, Le Sourd said: “For example, in August 1998, during the Russian financial crisis, the short selling strategy gained practically 25%, while at the same time the S&P 500 lost more than 14%.
“In October 2008, during the banking and financial crisis that followed the subprime crisis of summer 2007, the short selling strategy achieved a performance of almost 12%, when the S&P 500 lost about 17%.”
Which strategies suffered?
The equity-oriented strategies were negatively impacted by the downturn in the stock market. The lowest return was the -2.49% reported by event driven strategies, followed by long/short equity (-2.37%).
Le Sourd explained that event driven strategy and long-short equity are characterised by significant correlation with major stock and/or bond indexes.
Event driven strategies exploit price movements related to the anticipation of events affecting the life of the company (merger, acquisition, bankruptcy, etc).
Long/short equity funds invest in both long and short equity portfolios, but with a long bias.
“Looking at Edhec hedge fund indices historical returns, we observe strong negative returns during market downturns (-5.52% in August 1998 and -6.25% in October 2008), correlated with the decline in stock market indices,” Le Sourd told Expert Investor.
The same thing is observed for the event driven strategy (-8.86% in August 1998 and -6.29% in October 2008).
However, all hedge-fund strategies clearly outperformed the S&P 500 Index, Edhec said.
In March, a few European countries applied temporary bans on betting against the prices of a range of shares as they were seeking to calm markets.
The European Securities and Markets Authority (Esma) announced temporary measures which forced investors to reveal more information about their short-selling positions in order to “address the current threat level to EU financial markets”.
Short selling has been blamed for exacerbating volatility during times of stress.