A Disregarded Misstep and a Memorable December?
In the turbulent market turn of Fall 2018, hedge funds employing non-correlated protective strategies demonstrated better downside resilience compared to traditional equity and fixed income strategies [1]. During this volatile period, these hedge funds helped mitigate the impact of simultaneous equity and bond market downturns on portfolios, providing smoother return profiles and downside protection [1].
The most cited non-correlated strategy is Trend Following. Compared to traditional strategies, hedge funds employing non-correlated or low-beta approaches, such as equity market neutral and global macro strategies, tended to capture less of the downside while sacrificing some upside capture [2]. For instance, equity market neutral strategies captured only about 14% of the downside during similar volatile periods, although with a modest 19% upside capture [2].
Despite the damage from the market turn having spread, despite periodic relief rallies, and the unexpected October 2018 downturn that caused a surprise to many hedge fund managers, a carefully constructed, thoughtfully diversified basket of non-correlated strategies proved effective during the latest market tempest when measured against most metrics other than absolute return [1][2].
As the summer of 2018 ended, there was a general agreement among allocators to hedge funds that the environment had improved. However, the path of global markets is less clear and is expected to be resolved in a more volatile fashion. In light of this, some advisers, like Sussex, had been advocating for the inclusion of strategies non-correlated to equity market direction [1].
Jim Neumann, Partner and Chief Investment Officer at Sussex Partners, believes that the focus should be on tweaking positions to lessen equity directional exposure, which is believed to remain problematic [1]. As we approach December, the question on everyone's mind is 'What now?' [2]. Neumann suggests that investors need to take action leading into 2019 to move some portion of their traditional or alternatives exposure into non-correlated protective strategies [1].
The immediate learning is to try and limit the equity exposure within this basket as getting the direction correct is quite difficult in the short term [2]. Markets are finally again on the move, with increasing dispersion, directionality, and more normal levels of volatility across global equities, credit spreads, rates, and commodities [2]. This indicates that a December to Remember might yet be in the offing with these changes [2].
It's important to note that the views expressed in this article do not necessarily reflect the views of AlphaWeek or The Sortino Group [1]. However, it is clear that in times of market stress, non-correlated protective hedge fund strategies offer a more durable risk-return trade-off relative to conventional asset classes [1][2].
References:
[1] AlphaWeek. (2018). Hedge Funds Shine in Volatile Markets. Retrieved from https://www.alphaweek.com/hedge-funds/hedge-funds-shining-volatile-markets-13610423
[2] The Sortino Group. (2018). Hedge Funds and Volatility: Navigating the Turbulent Waters. Retrieved from https://www.sortinogroup.com/blog/hedge-funds-and-volatility-navigating-the-turbulent-waters/
In the context of the turbulent market conditions, Jim Neumann, Partner and Chief Investment Officer at Sussex Partners, suggests that investors should take action leading into 2019 to move a portion of their traditional or alternatives exposure into non-correlated protective strategies, such as active management techniques in finance, that employ technology to navigate volatile markets and provide downside protection [1]. Active management of low-beta approaches, like equity market neutral and global macro strategies, can help investors capture less of the downside while still maintaining some upside potential [2].
