Hedge funds capitulate, investors brace for margin calls in market rout

HONG KONG/SHANGHAI/NEW YORK (Reuters) -Some hedge funds say they are offloading all or most of their holdings of stocks as U.S. President Donald Trump's trade war wipes out trillions of dollars of market value and forces them to curtail trading using borrowed cash.

In the three trading days following Trump's announcement of broad reciprocal tariffs on almost all countries, stock markets across the world have plummeted, and bonds have become both a haven and a bet on rate cuts by the Federal Reserve, turning on their head market assumptions before Trump took office.

The selloff on Wall Street has been vicious as investors that bet on U.S. exceptionalism and economic might stampede out of its markets.

The benchmark S&P 500 index fell 10.5% over two days and lost about $5 trillion in market value. China's CSI300 blue-chip index fell more than 5% on Monday, while the pan-European STOXX index is down over 14% from its March 3 all-time closing high and in correction territory.

William Xin, chairman of hedge fund Spring Mountain Pu Jiang Investment Management based in Shanghai, said he had liquidated all of his stock positions as the current geopolitical landscape is messy, and the risk of a global recession is rising.

"The macro picture is getting very chaotic, and I cannot see the future clearly at all," said Xin, who sold his China and Hong Kong-listed shares last Thursday, ahead of a public holiday on Friday.

As repositioning away of U.S. assets is likely to continue in the short run, Tara Hariharan, managing director at global macro hedge fund NWI Management, said trade ideas currently do not include stocks at the moment. New York-based NWI favors long Japan's yen versus the dollar and long the front-end of U.S. treasuries.

Hedge funds that pursue a long-short equity strategy have been particularly hard-hit as market volatility metrics surged, brokers said.

Hedge funds have been minting short positions at a breakneck pace. JPMorgan estimated net leverage, which refers to hedge funds' long minus short positions, was down and could be around the lowest since late 2023.

Commodity trading advisor funds, which trade future contracts, are bearish stocks at a record level, according to JPMorgan.

The positioning, the bank's equity strategy team, leaves them more susceptible to a squeeze if "there are any positive headlines." A short squeeze occurs when a stock price goes up and forces market participants to close their bets against the stock.

In an indication of prolonged pain, the bank said on Friday that volatility targeting portfolios had between $25 billion and $30 billion in equities to sell in the coming days, while levered exchange-traded funds (ETFs) had an additional $23 billion to sell.

MARGIN CALLS

Hedge funds typically use margin accounts in which they borrow cash from prime brokers to trade markets.

When the value of holdings in an investor's margin account falls below the broker's required deposit, brokers can call on an investor to top up the account with cash or to sell those stocks or bonds.

That rush for cash has seen even gold, typically a safe asset during crises, fall sharply since Trump's "Liberation Day" tariffs were unveiled on April 2.

"In market selloffs like this, panic and forced selling via margin calls can dominate for a while," said David Seif, chief economist for developed markets at Nomura in New York.

"That's not to say that it isn't based on a very real negative event, which is these tariffs. But I think the ensuing selloff can take on a life of its own."

As an additional sign of capitulation, Morgan Stanley equity strategist Michael Wilson said in a note there are some indications of forced selling or liquidation in the market as even defensive stocks, which tend to outperform in economic downturns, were being sold.

FALLING KNIVES

Bob Zhang, managing partner of Pine Street Capital, a Beijing-based hedge fund, said he has cut net exposure to Chinese stocks to 25% now from 100% in January. He has also added some hedges on the stock index to protect against downside risk.

"The volatility in China might just be starting, as positions are very crowded, and some people are trying to catch a falling knife."

Chinese investors are somewhat less likely to be affected by margin calls as the market had risen a lot earlier this year, yet the country is also the target of the biggest Trump tariffs.

The Hong Kong tech sub-index is down more than 27% in a month and back to levels at the start of the year.

China faces fresh U.S. tariffs of more than 50%, and it responded in kind on Friday by slapping extra levies on U.S. imports.

"Too many uncertainties around, and everyone is de-grossing given the elevated market volatility" said a portfolio manager at a large U.S. multi-strategy fund, based in Hong Kong.

"I think we are just in the middle of this selloff. This position unwinding usually will be sequentially affected from one hedge fund to another."

Outstanding margin finance in China remains high, at 1.9 trillion yuan ($260 billion) as of April 3.

In South Korea, where a ban on short-selling of shares was lifted just this month, data from the Korea Financial Investment Association (KOFIA) shows there were a total of 28 billion won ($19.15 million) worth of stock sales between April 1 and April 3 triggered by margin calls, compared with 11.5 billion for the whole of March, which was the biggest since September 2023.

($1 = 1,462.3100 won)

($1 = 7.3077 Chinese yuan renminbi)

(Additional reporting by Isla Binnie in New York, Scott Murdoch in Sydney and Jihoon Lee in Seoul; Writing by Vidya Ranganathan; Editing by Jamie Freed and David Evans)