Hedge funds have successfully turned around the underwhelming performance they posted last year by capitalizing on widespread market volatility seen during 2023, new research shows.
In November, top funds profited on soaring stock and crypto markets as they jumped on the rally caused by investors pulling out of bonds amid declining yields caused by a drop off in inflation.
The shift saw hedge funds achieve their biggest gains since January as they finished the month up 2.2%, data from HFR shows.
This followed a successful year for the sector during which those funds capitalized on market volatility, including the volatility caused by the banking crises in Europe and the U.S., by profiting on stress in the markets.
“The volatility that we’ve seen, not only in November, but going back throughout the year, has seen a situation where a lot of funds have been able to operate as liquidity providers, by buying in on weakness,” HFR CEO Kenneth Heinz told MarketWatch.
“Hedge funds were able to navigate that volatility and take advantage of the fact there was a lot of forced selling and capitulation in the marketplace by other participants, and hedge funds were able to operate in a way that they were providing liquidity,” Heinz said.
“Over time those equities were covered and that allowed some of the funds to do well, because they were able to buy in during a period of stress,” Heinz said.
The situation saw HFR’s Equity Hedge Index post gains of 5.09% in 2023 so far, compared losses of 10.13% in 2022. In November alone, the index posted gains of 2.93% as hedge funds capitalized on surging stock and crypto markets.
Hedge funds, however, failed to achieve the gains seen during 2020 and 2021, when capital markets surged in response to the COVID-19 pandemic.
Earlier this year, the run on Silicon Valley Bank saw the U.S. financier forced to sell $21 billion worth of securities, in order to cover its customers’ withdrawals.
In Europe, hedge funds made millions by shorting Credit Suisse as shares in the Swiss bank plunged 71% before it was acquired by Swiss rival UBS in a state-backed deal worth CHF 3 billion ($3.4 billion).
More recently in November, hedge funds achieved their highest monthly gains since the start of 2023 as they profited on the surge in equity and crypto markets that was driven by investors pulling out of bond markets in response to falling levels of inflation.
“People have been led to believe that the Fed is done lifting interest rates,” Heinz said, as he explained hedge funds shifted from taking a more defensive approach over the summer towards more opportunistic strategies in November.
Looking forward, Heinz said markets are now anticipating a boom in M&A activity, following a dearth of deals in recent years.
He explained that global lockdowns during COVID-19 followed by a two-year period of soaring interest rates has led to a dearth of deals, as market players have been reluctant to take part in transactions.
Now, the latent demand that has built up is set to come to the fore, as big tech companies with “tons of cash on their balance sheets” look to pick up smaller companies. Investors are now pricing in the potential for deals, Heinz said.
“You’ve seen a decent increase in small caps and there’s an element of people pricing in an improving M&A environment,” Heinz said.