The Hedge Fund Risk of Risk-On, Risk-Off
The Dow opened down 1000 points on Monday. The S&P was down 5%. All this, on the heels of a one-week decline of the S&P500 of more than 5%. Risk assets seem to have lost their favor, and the risk-on, risk-off trade is back. Who’s most sensitive to the trade? Hedge funds.
Daniel Loeb, Leon Cooperman, and Bill Ackman have crossed far into the red in August. Writes Alexandra Stevenson and Matthew Goldstein at the New York Times
Mr. Cooperman’s Omega Advisors posted a 12% decline this month through Wednesday and 10% this year. Mr. Loeb’s Third Point LLC and William Ackman’s Pershing Square Capital Management are also down big, erasing their gains for the year.
What is risk-on, risk-off?
Risk-on, Risk-off brings us back to mid-2010. The European crisis was in full swing. On good days, the equity markets would rip while gold and treasuries would decline. On bad days, equity markets would swoon, while investors would rush back into treasuries and gold. Investors were either chasing risky assets or doing everything they could to stay away from them. It didn’t matter how good your stock-pick was. Correlations were high, and investors were either risk-on or risk-off. RORO.
Why are hedge funds sensitive to risk-on, risk off?
When the market loses its taste for risky assets, correlations between risky assets increase, and they decline in tandem. A hedge fund manager’s ability to pick winners and short losers becomes less important. The only skill that gets rewarded is the ability to pick the market-direction, not the underlying stocks.
Hedge fund manager decisions may have additional sensitivity to the risk-on, risk-off trade. When a manager takes a position in a stock, they have exposure to risks such as liquidity, concentration, and crowdedness. A market-shock like today’s, unsurprisingly, will often impact less liquid stocks dramatically. Without a plentiful group of buyers and sellers, a market shock will leave many sellers without corresponding buyers.
Highly concentrated positions are also at risk. Take, for example, Spirit AeroSystems Holdings, Inc. (SPR). Scopia Capital Management is by far the largest hedge fund holder and the largest holder of SPR, having taken on considerable concentration risk, holding more than 12% of the company. On the Friday close, SPR was trading at $51.60. It hit a low of $47 Monday morning, down almost ten percent, far exceeding the movement of the market.
Symmetric.io has aggregated the inputs and corresponding connections to isolate hedge funds that may be more sensitive to the dynamics engendered by the risk-on, risk-off trade. We’ve boiled it down to the top ten. For more information, register here.
