Despite their reputation for taking advantage of upsets in the markets, hedge funds wisely ran for the exit from stocks between 2007 and 2009, according to a report by Ohio State University’s Fisher College of Business Assistant Professor of Business Itzhak Ben-David. Ben-David conducted the study along with Rabih Moussawi of the Wharton School at the University of Pennsylvania and Francesco Franzoni of the Swiss Finance Institute and the University of Lugano.
The study found that hedge funds reduced their stock holdings about 10% in the second half of 2007, as the credit crisis began. Then, in the second half of 2008, the average fund scaled back its equity exposure by another 30%. By comparison, mutual funds scaled back their equity exposure dramatically less, about one-tenth of these pullbacks.
This rewarded hedge funds with noticably better performance. From 2007 to 2009, the average hedge fund fell -1.82% in value, while mutual funds lost an average of -7.22%.
“Hedge fund investors rushed to the exits when stock prices started falling,” Ben-David said. “As a consequence, hedge funds heavily sold their stocks. That left mutual fund clients to bear the full brunt of the falling market.
“When we think of hedge fund investors, most experts see them as the people who rush in whenever these is a stock crash or economic crisis to find a way to make money,” he continued. “They are seen as sophisticated investors who find a way to exploit a bad situation for their own benefit.”
But, in fact, hedge funds bailed on stocks, making the market even more volatile, he said.
Currently, hedge funds' short bets against the S&P 500 are at their highest since December 2008, according to a report from Societe Generale. Hedge funds "have switched to a massive net short," said Alain Bokobza, head of allocation at the bank. "They have reacted very strongly to the recent economic and political newsflow. It's a very important figure. It indicates just how pessimistic hedge funds are."
Bokobza essentially agreed with the professors' report that hedge funds' bailing out of equities and taking short positions is exacerbating the S&P 500's decline and market volatility.