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Hedge Fund Exposure: My Two Lessons

6 January 2015

Most investors in hedge funds have started reading the annual reports coming from managers of

(portfolios of) hedge funds. But how long are their memories, what are the reference points? The

most popular broad hedge fund market indexes, the HFRX/HFRI family, will publish 2014

performance numbers this week. Arguably, 2011 was much worse, by about 8% for these indexes.

Back then even CTAs did not perform. But what lessons could have been learned from 2011, or from

2008? I would like to share my own.

About ten years ago I started drifting from hedge fund research and selection in direction of hedge

fund indexes and their “alternative” Betas. Old lessons are classic: managing the hedge fund capacity

and redemption constraints. My first new lesson was in 2008: one should be able to utilise both sides

of these “smart” Betas, long and reverse, as and when needed. The second lesson was received in

2011: QE and other subsequent policy interventions distorted many relationships captured by hedge

fund tracking and predictive models (e.g. by influencing market volatilities). Two years later I have

decided to handle the modelling and index product errors and uncertainties by approximating the

hedge fund market neutrality, through simultaneous long/short positions in the alternative indexes.

Welcome to 2014, when hedge fund market has been range bound until last autumn. Two rapid

downturns occurred in October and December; CTAs did exceptionally well. Many portfolios of

hedge funds could have benefited from exposure to a single CTA index tracker ETF (black).

Alternatively, a managed exposure to just two hedge fund index products (green) happened to catch

up with this ETF, but there are some obvious differences between two paths. Could this – or maybe I

- be of any help in 2015?