Thursday, January 24, 2008

High hedge fund/S&P 500 correlation = Bad News for the hedge fund industry?

Hedge fund returns remain highly correlated to the S&P 500, as I have pointed out before and this is a negative development for the hedge fund industry longer term. The latest available figures to Jan 18th show that the S&P 500 was down 9.8% YTD, while the HFRX Global Hedge Fund Index was down 3.0%


When the Tech Bubble burst in 2000 and equities went down in the ensuing bear market, hedge fund returns were uncorrelated to equity returns. Thus, they appeared attractive as an alternative investment because of their alpha and their low correlation to equities and other asset classes. Given this recent persistent high level of equity correlation, investors will no doubt begin to question the role of hedge funds in a diversified portfolio.


Even Equity Market Neutral Funds are correlated
The accompanying chart shows the returns of the HFRX Equity Market Neutral Index (-3.0% YTD) versus the S&P 500 (-9.8% YTD). Returns started becoming more correlated in late 2005 and early 2006 and have more or less continued to this day. For a group of funds that is supposed to be non-directional to the market their returns are exhibiting a very high market beta.






Addendum: Information Arbitrage has a similar view in his post Ratchet down your expectations for hedge funds and private equity funds.

4 comments:

Przemek said...

All I can see that a blue line and a red line got more correlated.
Does it mean that every HF strategy is correlated to S&P?
Big generalisation...

Humble Student of the Markets said...

It doesn't mean that every HF strategy is correlated to the S&P 500. It just shows that if you aggregate HF strategies together they are correlated to the S&P 500.

Subtle difference...

Przemek said...

HSM I understand this subtle difference. It is nice academic fact. But it says nothing to an active investor...or if one could invest in the HF indices, well that would be something worth looking at.

Humble Student of the Markets said...

You can invest in the investable hedge fund indices such as HFRX. Some of the major investment banks will write you a derivative contract on many of these indices.