Goldman Sachs has made the announcement that everyone has been waiting for. The investment bank admitted yesterday that three of its high-profile hedge funds had off-loaded massive equity holdings following days of stock market turbulence.

In recent days, whispers at rival fund managers had blamed a fire sale at Goldman Sachs for the devastating downward spiral afflicting global financial markets. The truth is that the bank was not alone. Almost every big quantitative fund using a strategy similar to Goldman’s – known as an equity market neutral (EMN) strategy – was suffering in its own way.

The result has been a rout of one of the most popular types of quant fund. Hedge Fund Research’s EMN index had lost 7.6 per cent by last Thursday and undoubtedly saw further points shaved off during Friday’s plunge in equities.

EMN funds make their money by identifying investment opportunities in a specific group of stocks, while neutralising their exposure to the sector. They do this by taking long positions on shares that they expect to out-perform the sector and short positions on those that they expect to underperform.

The managers of the EMN quant funds set the criteria for the share purchases, based on elements such as price/earnings ratios. Once the parameters are set, sophisticated computer programs take over the business of trading. Until last week, City wisdom held that the funds were incapable of producing heavy losses.

One leading fund of hedge funds manager expects EMN’s difficulties to hit the reputation of quant funds as a safe harbour for investors. “Previously they had a reputation of being good protection because they couldn’t make a loss,” the fund manager said. “People know now that that’s not true”.

But experts do not expect the long-awaited hedge fund blow-up to come from the quants. John Godden, chief executive of IGS Group, the hedge fund consultancy, said: “The funds will endure short-term pain but you’re not going to get a meltdown of asset values because they remain in the liquid end of the spectrum. It’s the derivative-linked stuff where you can see the possibility of the values hitting zero.”

Equity quant funds have made strong, stable returns over the past few years, which has attracted the interest of large multi-strategy hedge funds. Big players such as Tykhe Capital, Goldman Sachs and Renaissance Technology have been allocating growing sums to EMN, with increasingly ambitious leveraging. According to Hedge Fund Research, investors pumped an additional $2 billion into ECM funds in the second quarter, taking the total amount invested to $40.7 billion.

In recent weeks, prime brokers have begun to make margin calls – asking their hedge fund clients to put up greater collateral in order to secure their credit lines. To cover their margin calls, the funds were forced to sell some equity assets. Most had invested in the same stocks, concentrating on value investments.

Jerome Berset, an analyst for Capital Management Advisors, the fund of hedge funds, said: “As those big players with huge leverage started to unwind their positions, covering shorts and selling longs, short names started to rally and longs started to fall and it started to hit the market.”

Once the market started to fall, hedge fund managers were pushed to sell more and more equities, at ever-decreasing prices, in order to obtain the cash they required. “Once one guy starts deleveraging, they all have to, and they try to do it more quickly than their neighbours,” a fund of funds manager said.

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