I don’t know where Brett Arends got his information, but below is the explanation I gave on what happened to long/short and market neutral funds. It had nothing to do with correlation to the market as I am sure you point out…

Some time near the end of July, Goldman Sachs began to unwind the 5X leverage of its Global Opportunities Fund. This is a long/short hedge fund quantitatively managed, but not market neutral. Estimates indicate this was in the area of a $20billion unwind. Understand that anunwind of this sort involves both buying and selling of equities to reduce long and short exposures. In this fund there was greater long exposure than short so the net transactional pressure was to push the indices down, but not by amounts that were unreasonable by historic market standards.

Inside the indices was a completely different story. The stock effects were that quality stocks were falling and lousy stocks were going up. The up and down effects individually were very different than the index which benefited from the countervailing impact of the stocks going up and the stocks going down. Not only did the short side have to suffer this ignominy, it also experienced a classic short squeeze, which increases borrowing costs dramatically.

Quantitatively managed hedge funds generally lever themselves to attain a desired level of total risk. The past year has seen overall risk levels fall to a secular low with the consequence that funds had scaled up their leverage to secular highs. When the Goldman transactions hit the market, the daily stock volatility spiked tripping the scaling (leveraging) variable. Simultaneously all leveraged, quant hedge funds started selling and buying just like Goldman, wreaking havoc in the market of stocks, but not the stock market. By August 10, it was over.

Who would be hurt most? There are three parts to answering this question. Quantitatively operated funds all base their portfolio selection and construction on similar notions. That is not say that they are exposed to the same stocks, but they do have similar exposures. Long/short and market neutral funds have exposures in two dimensions and both were being assaulted. Finally, higher leveraged funds will have exaggerated long and short exposures making the assault punitive indeed.

All this adds up to say the candidates for being dunned the most are quantitatively managed, highly leveraged, long/short and market neutral funds. Unleveraged versions of these strategies, such as those run by Analytic and PanAgora for institutional clients, fared much better.

The effect on the market was transitory. After this brief, brutal dislocation, mean reversion kicked in and many regained their lost value and the most prescient actually outperformed. Those that did not comprehend what was going on and/or could not releverage as fast as they had deleveraged had substantial losses with the result that many funds could be wound up.