Hedge funds are most susceptible to a 2001 NASDAQ-style crash, according to recent stress tests carried out by research firm eVestment. Stress tests done on 30 hedge funds with a combined $370 billion assets under management found that a crash similar to the collapse of the dot com bubble would cause them to lose 2.29% on average, compared to just 1.59% in the event of a crash similar to the recent global financial crisis, which came in fourth, and compared to the more than 25% that the NASDQ actually lost when the tech sector fell apart.
The market downturn following the 2001 World Trade Center attacks would be the second most damaging event while the third is the downturn following the 1990 Iraqi invasion of Kuwait. A crash similar to the events of Black Monday in 1987 would actually allow for a 0.34% gain, the only historical stress test that didn’t cause at least some loss.
Beyond the historical stress tests, eVenture also tested 10 different factors that could independently cause the hedge funds to lose money. “When individual factors are stressed, the largest portfolio losses are expected to result from exposure to US investment grade fixed rate asset backed securities. While this factor is specific to the US domestic market, it is indicative of this group’s exposure to global securitized credit markets,” the eVenture report says.
Hedge funds benefited from some degree of market volatility
eVenture found that while the portfolios would lose value if the US dollar dropped while holding all other factors constant, when they also calculated knock-on effects of a weaker dollar the hedge fund portfolios actually had increased expected returns. The hedge funds also benefited from some degree of market volatility, although a sudden spike in volatility did harm expected returns.
The hedge funds distributed a long bias on most assets (notably not on oil, the report points out) which is in line with a general consensus that the economy is recovering. Of course it’s easier to prepare for problems that the market has experienced in the past than some unknown shock down the road, but if eVenture’s stress tests are sound than at least hedge fund managers are learning from others’ missteps.