Hedge Funds Are Effectively Playing Defense
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It’s been a tough year for all investors as nearly all passive asset investments have lost money except for concentrated commodity positions. Despite the broadly down markets, Hedge Funds have done pretty well - losing a little more than 4% through October before fees. These funds have been able to maintain their performance by playing defense through much of the year. Leverage is close to lows, equity positions are tilted more to value relative to history, and the Hedge Fund community is positioned for inflationary dynamics with low duration exposures and long commodity positions. Protecting capital during down market environments may not generate big headlines, but it's prudent asset management that any investor could learn from in this challenging environment.
Below we discuss the performance since the start of the year in more detail. To start, here is some perspective on how Hedge Funds have performed relative to other asset classes. Hedge funds have been the best major asset class other than concentrated positions in commodity assets.
In any given year it's normal for some strategies to do better than others. Over time the diversification creates a more consistent return than any single fund strategy. This year is no exception with the strong performance in decades for Managed Futures and Macro offsetting declines in L/S Equity and Emerging Markets. And while these strategies have been maligned in the press, both have handily beaten their benchmarks by delivering hundreds of basis points of alpha.
The way these funds have succeeded in preserving capital effectively during this challenging year is by positioning quite defensively. Using our proprietary technology we develop a measurement of how we believe hedge funds are positioned. The most recent information we see suggests that funds in aggregate are playing defense by running relatively low leverage versus history.At the asset class level these funds are also positioned relatively defensively. Equity exposure is much lower than normal and credit is a bit lower as well. Funds are also holding no net bond exposure which is rare given their typical exposures.
Even within stock market positions, these funds are positioned quite conservatively. Long positions in growth stocks and foreign stocks are close to their lowest in decades. That is offset by larger positions in value oriented sectors as well as smaller companies that are generally at lower valuations than the large and mega cap counterparts.
Hedge funds have navigated this year better than the vast majority of investors. The way they have done it is by playing defense. Investors could benefit from taking this type of approach to their own portfolios to help navigate one of the most challenging periods that many have faced in years.