Despite being the financial boogeyman, kicked around by politicians and vilified on television, hedge funds are a smart way to protect hard-won investment gains as well as garner a certain amount of liquidity during periods of market stress. Like now. But the term "hedge funds" is broad. For instance, this past week Bank of America announced that hedge funds just bought a record amount of equities during the market plunge, yet the next day the Wall Street Journal reported that many hedge-fund managers have stepped aside and are "stockpiling cash." So which is it?
Probably both, after all, "hedge funds" encase many different strategies. BarclayHedge lists 17 different hedge fund indexes, from equity long/short funds to fixed income to global macro to Healthcare & Biotech and Pac Rim Equities. Commodity trading advisors (CTAs) have their own breakdown, but often are put into the hedge fund or absolute return buckets of institutional investors.
Like other investment funds, performance can vary with strategy. For example, in 2015, the worst performing hedge fund index according to BarclayHedge was distressed securities, down 9.86% for the year. Yet according to Hedge Fund Research, over a 15-year period the strategy returned a compounded average of 7.4%. Then there are merger arbitrage funds, which according to BarclayHedge had the best 2015 average return: 7.88%. Yet according to HFR, its 15-year compounded return was 4.3%.
This analysis also applies to CTAs. Overall, the Barclay CTA index was down -1.25% for 2015, while currency traders were up an average 4.50%. The return of the BTOP50 index, which is an average of the largest CTAs, fell almost 1% in 2015, although this year so far it's up almost 5%. Again, looking inside the average is key: Aspect Capital, a systematic diversified futures program, ended the year up almost 8% (this after a 32% gain in 2014), whereas another fund, Cantab Capital Partners' CCP Quant Fund, was down just over 8% in 2015 (although was up 39% in 2014).
The point is: There are many strategies within hedge funds, and picking the right strategies for these times can be essential to protect an investment portfolio.
Lyxor Cross Asset Research, a managed account platform, states in its bi-weekly letter dated Jan.18 that "Hedge funds, which have adopted a defensive stance over the course of the second half of 2015, have been able to navigate the turmoil without major damage." They note that though the Lyxor Hedge Fund Index was down 0.8% as of Jan. 12, 2016, CTAs were up 3.65%, largely due to being long fixed income, long the U.S. dollar and short commodities, as well as having deleveraged equity positions in early January. So should investors jump into commodity funds? Maybe. Lyxor concludes "Going forward, CTAs appear as the best hedge against additional nasty market developments. We believe that the market concerns are somewhat exaggerated but the momentum and sentiment is so negative amongst the market participants that it seems too early to lean against the wind. We stick to our recommended allocation, which involves a preference for hedge funds with a relative value approach and limited market directionality."
