EQIRA: Empirical and Quantitative Investment Research and Analysis

Hedge Funds Weekly: September 28, 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 lost 0.76% last week while our factor-attribution analysis indicates that long equity exposure, both foreign and domestic, was the primary return driver. US equity beta contributed 0.42% towards the loss and the spread between foreign and domestic equities contributed another 0.23%. The losses overpowered gains of 0.06% from foreign developed currencies and 0.11% from alpha. Hedge funds’ aggregate month-to-date and year-to-date performance now stands at -0.87% and -0.34%, respectively.


Global Benchmarks

It was a rough week across the board as all major asset classes save commodities posted losses. Currency exposures had a particularly strong impact on foreign asset returns, as developed and emerging currencies fell 2.01% and 1.58%, respectively, against the dollar.

US equities lost 1.63% on the week. All styles declined, but small caps and growth stocks performed the worst. Most sectors were down. Only utilities, consumer staples, and financials were able to record gains. Healthcare, at -6.37%, and MLPs, at -6.25%, where especially hard hit.

Foreign equities were universal losers, with developed equities declining 3.11% and emerging equities falling 4.50%. The losses were relatively similar across regions.

Short-dated US Treasuries eked out a small positive return, but maturities longer than a few years all lost value. Inflation-linked securities and instruments with embedded credit risk fared even worse. Foreign bonds rode currency losses to healthy declines.

Real estate securities managed to minimize their losses, which was impressive given the carnage elsewhere. US REITs fell only 0.17%, while foreign real estate declined 0.41%.

Commodities broadly rose. Agriculture futures soared 3.27%, energy futures gained 1.47%, and precious metals futures added 0.51%. Only base metals bucked the trend, losing 3.47%.

All of our multi-asset class benchmarks fell. Our global 60/40 and risk parity indexes declined 1.93% and 3.19%, respectively. The US versions fared better, losing only 1.07% and 1.56%. Needless to say, the levered foreign currency exposure embedded in the global risk parity strategy was particularly harmful.


Market Factors

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

Although commodity beta strategies rose, commodity alternative beta strategies suffered. Momentum and trend following strategies fell in excess of 1%, while commodity term structure plummeted by 2.95%.

Investment grade bonds underperformed US Treasuries by 1.02%, while high yield underperformed investment grade by an additional 1.38%. Emerging market high yield bonds declined 1.84% relative to developed high yield bonds and 3.73% relative to emerging market investment grade bonds.

Healthcare stocks were absolutely crushed last week, underperforming the broad US market by 5.60% on a risk-adjusted basis. Other notable laggards included MLPs relative to REITs, small cap stocks relative to large caps, growth stocks relative to value stocks, and foreign stocks relative to US stocks. Momentum and trend following strategies worked both domestically and internationally.

Longer term Treasury, non-Treasury bond, and foreign government bond spreads all notched losses. Foreign securities were very hard hit by the 3.01% and 3.11% risk-adjusted declines of developed and emerging market currencies, respectively, relative to the dollar.

FX alternative beta strategies worked well, as FX momentum gained 2.53% and FX value added 3.11%. Multi-asset class momentum and trend following strategies also did well.

Real estate performed well globally, as REITs outperformed US equities by 0.91% and foreign real estate outperformed foreign equity by 2.08%.


August 2015 Estimate Review

The indexes underlying our hedge fund composite indexes have all reported preliminary August returns. As currently stands, we correctly predicted the direction of 28 of 30 strategies. Eight estimates were within 25 basis points of the true index return; eight more were within 50 basis points. Our hit rate was above average, but our accuracy was 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 -2.12% by 19 basis points, which is not bad considering the size of the return. We overestimated performance in 17 strategies, most significantly in Emerging Asia (1.97%), Equity Value (1.87%), and Equity Long Only (1.02%), and underestimated performance in 13, most significantly in Equity Short-Bias (3.58%), Europe (1.33%) 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 -4.69%, even after fees, suggests that short-biased funds were likely employing leverage, perhaps in the form of long puts.

Overall, our forecasts 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 witnessed an unusually high divergence in strategy returns between index providers. The spread between the highest and lowest return in Equity Short-Bias, for example, was 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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