Q: Can you discuss hedge fund performance given the market backdrop?
In 2018, the U.S. equity market was down about 4.4%, while global equities were even worse, down 8.7%. If emerging markets are included, equities were down 9.4%.1 That was an environment when hedge funds, measured by the HFRI Fund Weighted Index, were only down 4.7%, which provided a nice cushion compared to global equities.
In comparison, hedge funds were only up 7.4% through August 2019 while equities were up 18%, 15% and 14% across the U.S., global and emerging markets, respectively. However, it’s crucial for us to also take a deeper dive into the more volatile times this year, which are May and August in particular. In May, U.S. equity markets dropped more than 6%. Hedge funds on the other hand were only down 2%, which provided a nice cushion.
A similar situation occurred in August 2019 as the S&P 500 Index was down 1.6% and global equities were down 2%, while hedge funds were only down 60 basis points. This demonstrates that alternatives have actually been able to somewhat protect investors over just investing in equities during volatile times.
Q: Can you talk about your recent observations on hedge fund performance across different categories?
In 2018, the Equity Hedge category was the worst performer and was down more than 7%. In comparison, Relative Value was almost flat for the year, while Event Driven was down 2% and Macro was down 4%. Fast forward to 2019 year-to-date (YTD) through August, Macro is actually the category that turns out to have had the best performance with gains of 10%. That is now followed by Equity Hedge (with returns of 8%) which was the worst performer in 2018. Relative Value and Event Driven are up 5% each as well but are up substantially less than the performance of other categories.
This tells us that it continues to prove very, very difficult to forecast or time exposure to individual alternative styles.
Q: Can you share some of the research that you’ve done on individual manager persistence?
We conducted a long-term persistence study spanning data from 2003 to 2016, and looked at the top 20% of hedge fund performers in any given year and measured where they were likely to rank in the following year. Less than a third of these top quintile performers in one year are likely to repeat a position in the top 20% just one year later. Additionally, almost a fifth of the top performers in one year are likely to end up in the bottom quintile in the next year instead.
If we focus on the more volatile environment of 2018 and 2019 YTD, the numbers are even more pronounced. Only 10% of fund managers were able to repeat in the top 20% for 2019 YTD, with a fifth of the funds ending up in the bottom 20% instead.
Overall, as these examples suggest, our findings indicate little evidence of performance persistence over time.
Q: Can you share how you think about investing in your alternatives program?
We take a diversified and varied approach to deliver hedge fund-like returns without directly investing in hedge funds. We do not invest in any hedge funds or external managers directly, instead we employ a wide range of liquid instruments, spanning for example single name equities, ETFs, futures, FX forwards and others.
We are looking to provide exposure to all the four main hedge fund styles: Equity Long Short, Macro, Relative Value and Event Driven.
We invest in a diversified bundle of liquid hedge fund market exposures and trading strategies by using our knowledge of the hedge fund industry and our data sources and technology. Our hedge fund knowledge comprises many individuals that have worked at hedge funds, have closely interacted with hedge funds or have been engaged in trading activities. This expertise and knowledge put us in a position to really get to the bottom of the systematic drivers of hedge fund returns. We then complement these fundamental insights with a range of data sources, including hedge fund return databases, prime brokerage reports, hedge fund consultants or public hedge fund filings such as 13-F, etc.
