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What happened to hedge funds’ alpha since the summer?

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While hedge funds’ performance and alpha were ‘honourable’ until the summer, analysis by Lyxor suggests that they erased about 2.5 per cent of alpha since June, with no turn in sight yet in September.

Lyxor writes: “L/S Equity funds were the primary culprits and victims. In the US, managers have steadily reduced their overall net exposure and leverage since Q2. As a result, they partially missed the summer rally. The plunge in Momentum also cost in June, only partially recovering afterwards. Stock selection in the heavyweight tech, healthcare and cons. discretionary sectors didn’t help enough. In Europe, funds adequately reduced their overall exposures ahead of the summer.”
“Unfortunately, many funds were too early in chasing Value stocks, which continued to correct. In Asia, funds had also turned cautious before the summer. However, they were caught in their long tech and Chinese positions, which strongly underperformed main markets. Within the L/S Equity space, neutral funds also suffered. In addition to the major swings in Momentum in the US and in Asia, and in Value in Europe, most other factors also proved volatile. It steadily eroded their returns. Finally, many managers report elevated hedging costs as one notable factor amid declining volatility in developed markets.”
“Meanwhile, the diversification from CTAs and Merger Arbitrage was of little help this time. Both strategies were flat or so. CTAs navigated a lack of trends in most segments, to the notable exception of EM markets. The tightening in deal spreads before the summer left limited leeway for Merger managers to extract substantial returns. The positions in Special Situation portfolios did generate some alpha overall, but more than offset by their costly long beta exposure. FI Arbitrage funds remained isolated but remained overall flat. “
“In our view, the difficult summer for hedge funds in general, and for L/S Equity funds, largely results from one central cause: worldwide policy uncertainty. The shifts in trade expectations, vulnerable progresses in Italy and UK, the anti-establishment push in a number of DM & EM countries, the intensifying use of economic sanctions all keep market in feverish stance, with limited source of uncorrelated returns. It prevents managers from deploying their strategy successfully.”

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