EQIRA: Empirical and Quantitative Investment Research and Analysis

Hedge Funds Weekly: September 21, 2015

The following is an excerpt from our Hedge Funds Weekly report, which is available in the clients section. If you are not yet a client, please request access.

Hedge Fund Performance

Our factor-based estimates project that hedge funds gained 0.05% last week while our factor-attribution analysis indicates that foreign equity spreads were the primary returns drivers. The outperformance of foreign equities relative to US equities contributed 0.15% and emerging equity outperformance contributed another 0.14%. The gains were sufficient to overcome losses from foreign exchange and multi-asset class factors, as well as four basis points of lost alpha. Hedge funds’ collective month-to-date and year-to-date performance now stands at -0.04% and +0.58%, respectively.


Global Benchmarks

Other than the utilities sector, which gained 2.53%, developed market equity returns were modest last week. Emerging market equities, however, rallied, gaining 3.09% in aggregate. They were fueled in part by a 1.22% gain in emerging currencies relative to the US dollar. Our Emerging Europe, Middle East, and Africa equity index led all benchmarks with a gain of 4.04%.

US Treasuries added 0.26%, while foreign developed government bonds rose 1.02% as the US dollar fell 0.96% against foreign currencies. Emerging bonds rose 0.64%, but only because of the gain in emerging currencies.

Real estate also did well, with US REITs adding 3.06% and foreign real estate rising 1.51%.

Although commodities collectively fell 1.56%, precious metals and gold increased 3.37% and 3.13%, respectively. Agriculture (-1.66%), base metals (-2.42%), and energy (-2.01%) were not so fortunate.

All of our multi-asset class benchmarks rose. Our global 60/40 and risk parity indexes added 0.65% and 1.44%, respectively. The US versions fared slightly worse, gaining only 0.10% and 0.74%.


Market Factors

Note: we report factor performance using excess returns risk-adjusted to an expected annual standard deviation of 10%.

Foreign currencies led the way as, risk-adjusted, emerging currencies gained 2.42% and developed currencies added 1.42% relative to the US dollar. Foreign exchange alternative betas were not so fortunate, however. FX momentum lost 1.76% and FX value declined 1.59%.

US real estate was strong, as REITs outperformed equities by 2.01%. Foreign real estate lagged domestic real estate by 1.57%.

Equity and fixed income factor performance was relatively modest, outside of a 2.25% gain in emerging market stocks relative to foreign developed stocks, a 1.91% increase in US utilities in excess of the broad US market, and a 1.07% gain in developed government bonds relative to US Treasuries.

Credit factors were generally weak, as investors seemed reluctant to take on credit risk.

Commodities broadly underperformed, losing 0.95%. Gold rose 1.80%, however, and all of our momentum, trend following, and term structure factors posted gains.


August 2015 Estimate Review

The indexes underlying our hedge fund composite indexes have nearly completed reporting preliminary August returns. As currently stands, we have correctly predicted the direction of 28 of 30 strategies. Nine estimates are within 25 basis points of the true index return; eight more are within 50 basis points. Our hit rate is above average, but our accuracy is a bit below average, which is not surprising given the volatility and magnitude of last month’s returns.

Our initial estimate of -1.93% for our broad hedge fund index return differs from the current estimate of -2.04% by only 11 basis points, which is quite good considering the size of the return. Thus far, we have overestimated performance in 18 strategies, most significantly in Emerging Asia (1.97%), Equity Value (1.87%), and Special Situations (1.01%), and underestimated performance in 12, most significantly in Equity Short-Bias (3.58%), Europe (1.32%) and Emerging Europe (1.29%).

The magnitude of the Equity Short-Bias estimate error is very surprising. Its size, coupled with the fact that the index gain of 5.53% is higher than the inverse of the Equity Long Only return of -4.64%, even after fees, suggests that short-biased funds were likely employing leverage, perhaps in the form of long puts.

Overall, our forecasts have resulted in an 89% reduction in variance relative to naïve forecasts of flat returns. The reduction is greater than normal, but again somewhat expected due to the size of the month’s returns.

Much like last month, we are seeing an unusually high divergence in strategy returns between index providers. The current spread between the highest and lowest return in Equity Short-Bias, for example, is a stunningly high 11.21%. The spread is a strong argument in favor of using composite indexes of indexes to evaluate hedge fund returns, rather than individual indexes.



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