The Impact of Recent Romantic Relationships and Present Economic Conditions on Diverse Investment Class Outcomes
In the two decades spanning from 2000 to 2018, multi-asset hedge funds demonstrated a remarkable ability to generate annual alpha of +6.63%, with a low correlation of 43% and a beta coefficient of 0.145 to the market. However, a significant shift in the relationship between major equity markets and their 10-year Government Bond counterparts has influenced the performance of these funds during this market cycle.
Historically, equities and 10-year government bonds exhibited a stable negative correlation, allowing multi-asset hedge funds to generate diversification benefits and more stable returns. Over the period 2000 to 2018, this relationship weakened or changed materially, resulting in decreased negative correlations, occasional positive co-movements, and changes in the beta coefficient.
For multi-asset hedge funds, which rely on the relative stability of correlations and beta to hedge risk and optimize return, this changing relationship has had several implications. It has reduced the effectiveness of traditional diversification strategies, led to higher volatility in fund performance, and necessitated adjustments in portfolio construction, including incorporating alternative hedging strategies or diversifying into non-traditional assets.
Factors contributing to these observed changes include monetary policy regimes and interventions, changing investor behavior and market structure, global macroeconomic shifts, and asset class evolution and securitization trends. Central banks' unprecedented quantitative easing and historically low interest rates, increased institutional participation, algorithmic trading, shifts in market liquidity, low growth and low inflation environments, geopolitical uncertainties, and securitization trends have all played a role in altering the traditional negative correlation between equities and bonds.
The analysis used the HFRI Diversified Fund of Funds Index as a proxy for the performance of hedge fund multi-asset class performance. Over the lifetime of the data (2000 - 2018), multi-asset funds outperformed the market with lower volatility, but most of this outperformance came from the 2000 - 2007 period. During the 2008 - 2018 period, multi-asset funds underperformed the market while nearly doubling their correlation and increasing their beta coefficient to the market.
In the current macroeconomic climate, equities are in their longest ever bull-run, widely considered as the 'most hated bull run' due to the artificial nature brought by central bank monetary policy, and a steep correction is widely expected. Given this context, family offices and institutional investors are advised to increase the amount of their investments into more uncorrelated products to lower the hurt that will come from an equity correction.
The author strongly believes that hedge funds have a very important role within an investor's portfolio, utilising the unique liquidity and tradeable markets characteristics of a hedge fund investment vehicle. It is extremely important that investors expand into more non-traditional markets in order to find truly uncorrelated returns via different market/price drivers and return behaviors.
[1] The author does not consider hedge funds, in general, to be their own asset class. [2] Commodities have shown an increasing relationship with equity markets since the Global Financial Crisis, remaining cyclical in nature in the long-term.
Institutional investors are advised to increase their investments into more uncorrelated products, such as hedge funds, to lower potential losses during an equity correction, recognizing the unique liquidity and tradeable markets characteristics of a hedge fund investment vehicle. Expanding into non-traditional markets, like hedge funds, can help investors find truly uncorrelated returns by leveraging different market/price drivers and return behaviors.
