History suggests that periods of market dislocation such as the present produce shifts in returns such that it is impossible to predict with any ce
History suggests that periods of market dislocation such as the present produce shifts in returns such that it is impossible to predict with any certainty which strategies will best be able to capitalise on market events, according to a new study released by Credit Suisse Index.
The report, Seeking Returns in Turbulent Markets: The Case for Hedge Funds During Market Downturns, argues that hedge funds in general have customarily exhibited trends of correlation in bull market runs and some decorrelation at market downturns.
A comparison between the Credit Suisse/Tremont Broad Benchmark Index, an asset-weighted broad benchmark of the hedge fund industry, and the MSCI World Index, a broad equity index, indicates that the 12-month rolling correlation between the two has dropped from its peak of 0.97 in June 2006 to 0.61 two years later.
Between July 2007 and June this year, the Credit Suisse/Tremont index increased by 4.09 per cent, compared with a decline of 12.5 per cent in the MSCI World Index and one of 13 per cent in the S&P 500.
The report argues that certain hedge fund strategies have historically performed well or mitigated losses while some strategies have been adversely impacted during periods of market dislocation, and examines how past trends may be playing out in the current market environment.
The authors say parallels may be drawn between the current market downturn and the events of 1997-98, when the Asian financial crisis and Russian debt crisis sparked the collapse of Long Term Capital Management – both periods marked by dramatic increases in equity market volatility caused by a reduction of liquidity within the markets.
The report notes the emergence of certain strategies that have enabled managers to manage losses. At the same time, the authors say, dominant return strategies have shifted over the course of previous market dislocations, and there is no way to accurately predict which sectors will be able to capitalise on market events in the future – reinforcing the precept that diversification is fundamental when considering investing in hedge funds.
