ISIS Potential Impact on Hedge Funds

New York (HedgeCoVest.Com) With news breaking that the Islamic State had taken control of the city of Ramadi in Iraq, Palmyra in Syria and Sirte in Libya, one has to wonder whether a third gulf war with full Western involvement is imminent. As IS expands its reach and seemingly becomes more organized each day, the airstrikes from the coalition led by the United States seem to be having little impact. With this being the case and with our industry being the hedge fund industry, we have to speculate as to whether hedge funds are investing with the possibility of war in mind.

Using the first Gulf War and the second Gulf War for perspective on what happened before, we looked at what happened to the S&P 500, gold and oil during each of the previous wars. In each instance, the specific dates are hard to define as far as a beginning and an end. The first Gulf War was certainly easier with August 2, 1990 being the day that Iraq invaded Kuwait, January 17 being the day the U.S. led coalition started a bombardment to expel Iraqi troops and February 28 being the day the coalition declared a cease-fire.

During this time period, the S&P was at $351.48 on August 2, 1990 and it fell to a low of $295.46 on October 11 for a drop of almost 16%. On January 17, 1991 when the bombardment started, the S&P spiked higher due to the initial success. After the cease-fire, the S&P moved sideways for the next month.
Oil took almost the exact opposite path of stocks over the course of the seven months of the conflict. On August 2, oil was trading at $23.11 a barrel and by the low in the stock market on October 11, oil had jumped to $40.42. When the bombardment started, oil prices dropped almost $10 a barrel on that day, from $30.29 to $20.63. By the day of the cease-fire, oil had fallen to $19.16 a barrel.

Gold shuffled around a little during the conflict, but it wasn’t nearly as volatile as stocks or oil. Gold was trading at $385.90 per ounce on August 2, $393.60 on October 11, $374.40 on January 17 and $369 on February 28, the day of the cease-fire.

The second Gulf War started on March 19-20 when U.S. soldiers, as part of another coalition, crossed the border in to Iraq. The fighting would continue for some time, but for our observation we used May 1, 2003 as that is the day that President Bush declared an “end of major combat operations”. This was the day of the press conference on the aircraft carrier the USS Abraham Lincoln where the “Mission Accomplished” sign was hanging behind the President.

Looking at stocks, oil and gold once again, we see less volatility among all three categories of investments. The S&P 500 was at $874.02 on March 19, fell to a low of $848.18 on March 31 and on the previously mentioned “end” date of May 1, the index was at $916.30. Turning our attention to oil, West Texas Intermediate Crude closed at $29.36 on March 19 and rose to $31.04 by March 31 and then fell to $26.03 on May 1. Gold moved very little during the second Gulf War with the commodity trading at $336.20 on March 19, $336.90 on March 31 and $342.40 on May 1.

While neither of the two Gulf Wars represents what a war with the Islamic State would necessarily look like, the first Gulf War is probably a better comparison as you had one country invading another and the U.S.-led forces came in to push those forces back. The IS would be more difficult as they are spread among different countries and there would be more fronts to worry about. With the first Gulf War, U.S. Intelligence knew of the Iraqi troop movements before the invasion of Kuwait. There doesn’t seem to be any such intelligence toward IS.

Regardless of the military strategy, the scenario begs the question, how would hedge funds invest if there is a third Gulf War? Some would argue that it has already started with IS advancing aggressively in the western part of Iraq and in to Syria. Do you invest cautiously in stocks or do you bet on a drawdown? Do you bet on an initial spike in oil prices?
One thing is for certain, should things escalate between the U.S. and IS and if ground troops have to be sent in, at the very least, stocks and oil will likely become more volatile and hedge funds and their strategies are better equipped to handle volatile markets better than traditional long-only investment management strategies.

While we don’t have data on the Credit Suisse Hedge Fund Index from the first Gulf War, we do have it for the second Gulf War. In the months leading up to the war, starting in December 2002 through the end of April 2003, the hedge fund index gained ground in all five months and gained 5.3% overall during the stretch. The S&P lost ground in December 2002 and in January and February of 2003 before jumping sharply higher in April 2003. In all, the index lost 1.3% during this five month stretch.

Rick Pendergraft
Research Analyst

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