The following series of scatter plots are based on data from Hedge Fund Research. As you can see, the urban legend that hedge funds “deliver absolute returns in good times and bad” was clearly never supported by the historical evidence. The following chart stacks the broadest index available, the HFRI Fund-Weighted Composite, against the monthly S&P 500 returns (since January 1990). The black line is the linear regression (the slope of which is the beta of the index vs. the S&P 500) and the red circle is September 2008.
While this index includes around 10,000 funds, a look below the surface at different sectors reveals some interesting trends. For example, about a third of this composite index is made up of the “Equity Hedge” category.
This index performed even worst last month than the broad composite. While September was clearly out of line with historical returns, the lion’s share (around three quarters) of this category is made up of “Fundamental Value” sub-strategy defined as being decidedly long-bias:
…typically focus(ing) on equities which currently generate high cash flow, but trade at discounted valuation multiples, possibly as a result of limited anticipated growth prospects or generally out of favor conditions.
To many, so-called “Market Neutral” funds are the prototypical hedge fund. While these funds only comprise a small portion of the constituents in the index, they stayed true to their name for most of their history - until September…
Thankfully, market neutral funds seem to be back to their neutral ways in October. Several weekly indexes are now showing them to be roughly flat so far this month (while other strategies continue to suffer).
The real winner (if you can call it that) was the “Macro” category. Those funds logged a narrow loss for the month, but actually beat what a linear regression suggests they should have delivered.
While September was bad for most categories, nowhere was the draw down as pronounced as in the “Relative Value” group. These funds pursue fixed income and volatility strategies. Multi-strategy funds are also included in here:
September’s data points stick out like a bump on a log. And by mid-month, October was looking equally grim for many of them. So that lonely blue dot may have some company pretty soon. Stay tuned.