Hedge fund returns are a combination of alpha and
beta risk exposure. The betas across different hedge fund styles are variable
and dynamic. In general, beta will be below one with the majority of hedge
funds showing market betas between .3 and .6. Some hedge fund styles like
managed futures may be lower. Alpha can also be highly variable; however, we
can say that in strong up markets hedge funds are likely to underperform the
market return. Similarly, in strong down
markets, it is not clear that hedge funds will generate a positive return in
down markets.
With SPX, as the market portfolio, down 1.73% and
the small cap index (IWM) down over 4 percent, hedge fund returns this month
were relatively attractive. At a .5 beta and a mix between large and small cap,
equity focused hedge funds should be down around 2 percent minus any alpha.
Those strategies like special situations, mergers and distressed which may have
lower beta and higher alpha performed better. Those styles that are directional
or may have higher risk given a focus on growth should have done worse. What
was surprising in October was the strong decline with systematic managers and
global macro managers. These styles should have done better in a down market.
The year to date numbers are mixed with only 5 out
of 19 HFR hedge fund style indices generating returns over 4%. Eight styles
have negative returns through October. Small cap stocks were up double digit
and the S&P 500 index was up over 7% over the same time period. Generalization
should not be made, but holding passive portfolios have proved to be a better
absolute return strategy so far this year.
A beta-adjusted (lower risk) strategy of stocks and
bonds would have done better than many hedge fund styles in 2016. This difference
has been increasingly the challenge put on hedge funds. Can hedge funds do
better than a similar beta stock-bond mix? Put differently, can hedge funds
generate consistent alpha? The answer seems to yes for some selected styles but
no for most.
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