Key Takeaways:
Systematic long/short hedge funds suffered their worst single-day loss in more than two years Wednesday as a Treasury bond-buyback plan and Moderna's surge upended momentum strategies.
Systematic long/short hedge funds fell 1.4% by 1 p.m. Wednesday, the worst single-day loss in over two years, as momentum trades broke.
"An earthquake of magnitude 7 will certainly be followed by aftershocks in the coming days," said a senior executive at a top quant hedge fund. "It won't go to zero directly, but market participants are reducing risk exposure."
Morgan Stanley's "pure momentum" index dropped more than 4% in a single session, the first such move in at least five years, even as the S&P 500 rose, according to a client memo seen by the Financial Times. The dislocation followed the U.S. Treasury's announcement that it would at least double purchases of long-term bonds to stabilize the debt market, and Moderna Inc. nearly tripling after reporting positive data from an experimental skin-cancer therapy.
The synchronized deleveraging threatens to feed on itself, as funds cutting risk in tandem magnify the volatility that triggered the selling. Systematic long/short funds remain up about 1.7% for the month, Goldman Sachs said, but the episode deepens a stretch of turbulence that began with July's AI-stock selloff, which pushed several funds into monthly losses.
The losses concentrated in funds with large "momentum factor" exposure — strategies that systematically buy rising stocks and sell falling ones. Morgan Stanley's client memo marked the first time in at least five years its pure-momentum gauge fell more than 4% in a day while the S&P 500 closed higher.
"It doesn't take many stocks like Moderna to make risk managers a bit panicked," said a portfolio manager at a large asset manager.
A hedge fund manager described the environment as "extremely abnormal," with options market makers "getting hurt on all sides." "The market rotates every day," the manager said. "What makes money today almost certainly falls tomorrow."
The episode echoes the "quant winter" of 2018, when automated strategies broadly failed for several years and profitability suffered. Goldman's internal memo showed the deviation of its global momentum index had moved far beyond its normal historical range.
The latest shock compounds a difficult stretch for the industry. In July, weeks of selling in AI-related stocks caught Wall Street off guard, and many hedge funds recorded monthly losses. The most prominent casualty was Situational Awareness, a highly leveraged AI-focused fund that was forced to sell most of its public stock positions at a steep discount to Citadel.
Even firms known for steady profits were hit. Jane Street, the dominant market-making firm, lost roughly $150 billion last month on bets tied to Situational Awareness and related AI stocks, according to reports.
The question now is whether the deleveraging has run its course. The earthquake analogy from the quant executive suggests more turbulence may lie ahead. For funds running momentum strategies, the risk is that further forced selling compounds the volatility that started the slide.
This article is for informational purposes only and does not constitute investment advice.
