Brexit may have triggered the biggest equity selloff in history, but for market neutral funds, it was simply another money making opportunity.
Market neutral was the clear winner after the United Kingdom’s shocking decision to quit the European Union on June 23. Fund strategies that employ offsetting bets in various markets outperformed directional investment strategies following the Brexit vote, despite widespread volatility stretching from Tokyo to New York.
Both long book and short book strategies helped asset managers distance themselves from massive market swings while still benefiting from disparities between markets and individual stocks. Statistical arbitrage portfolios and other quantitative trading methods were able to capture gains during the two-day rout that wiped more than $3 trillioni from the global financial markets.
The S&P 500 large-cap index fell 5.33% in the two days following the Brexit vote. For the month, the index rose only 0.29%. By comparison, GL Asset Management’s Statistical Arbitrage Portfolio – a market neutral strategy with exposure to a cross-section of healthcare, basic materials, technology, services and consumer goods industries – delivered a monthly return of 1.24%.
Clearly, market neutral strategies proved highly effective in the post-Brexit environment. This is especially true for portfolios that focused on equity fundamentals in additional to highly quantitative models.
There’s strong reason to believe that market neutral strategies will continue to pay dividends for the foreseeable future, as investors struggle for direction in an environment characterized by heightened geopolitical risks and weak economic growth.
The risks facing the UK are expected to intensify in the medium term as the Conservative government elects a new prime minister and sets out a plan for negotiating new trade terms with the EU. The UK economy is widely expected to enter into recession in the coming years as a direct result of the Brexit vote.ii This will have broader implications on the EU.
Bank of England (BOE) Governor Mark Carney recently stated that monetary easing is likely over the next two months. Under his guidance, the Financial Policy Committee lowered the so-called countercyclical buffer for UK banks to zero from 0.5% of risk-weighted assets. This essentially raises their capacity to lend by as much as £150 billion.iii
Mr. Carney has made it abundantly clear that the risks attached to Brexit are beginning to materialize. This will no doubt continue to manifest itself in the financial markets in the short- and medium-terms.
In this environment, so-called directional hedge funds that bet on markets going up or down could find themselves on the wrong side of the trade in alarming frequency. Consider that the strong majority of hedge funds, market analysts and even pollsters expected the UK to remain part of the EU after June 23. Hedge funds and asset managers that bravely bet on a binary outcome, such as Leave-Remain, lost a lot of money. This makes sense when we consider that four out of five European hedge fund surveyed in early June expected Remain to win.iv
While it’s nearly impossible to predict just how the future will play out, market neutral strategies appear to be performing strongly in an environment that will likely witness repeated bouts of volatility. The fallout from Brexit and the threat of contagion it poses to the rest of Europe are expected to play out over many years as the UK reconfigures its trade agenda with its regional partners.
i Javier E. David (June 27, 2016). “Brexit-related losses widen to $3 trillion in relentless 2-day sell-off.” CNBC.
ii Will Martin (July 1, 2016). “One bleak chart shows how awful the next few years will be for the British economy.” Business Insider UK.
iii Scott Hamilton, Jill Ward and Paul Gordon (July 5, 2016). “Mark Carney warns financial shock from Brexit crystallizing as Bank of England eases bank rules in ‘major change’.” Financial Post.
iv Preqin (June 16, 2016). Four-Fifths of Europe-Based Hedge Fund Managers Believe Britain will Remain in the EU.