Tue, May 31, 2016
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Industry Updates

Hennessee: Hedge funds struggle with ‘new market order’

Thursday, November 04, 2010
Opalesque Industry Update - Stock Correlations at Historic Highs While Low Quality Stocks Outperform

Hennessee Group LLC, a consultant and adviser to direct investors in hedge funds, believes the spike in correlation between individual stocks has made alpha generation a challenge in 2010, particularly for fundamentally based long / short equity hedge funds.

Charles Gradante, Co-Founder of the Hennessee Group, stated “The ‘risk on-risk off’ trade, driven largely by macro sentiment, continues to dominate the financial markets.” Gradante added, “Until we see fundamentals return to the forefront of investing, we believe hedge funds will have difficulty executing their investment strategy, particularly on the short side.”

In addition to the spike in correlation, the Hennessee Group believes the continued outperformance of high beta, low quality stocks, as witnessed in 2009, is adding to an already challenging investment environment in 2010, particularly for hedge funds seeking to generate alpha in their short portfolios.

Stock Correlations at All Time Highs (see chart here: Source)

The “risk on–risk off” trade, driven by major macro themes such as the economy and regulation continue to dominate the financial markets. The "risk on" trade is best characterized by an uptick in investor confidence as they seek out risk assets including stocks, high yield bonds, emerging markets and commodities. During the “risk on” trade, the market experiences sharp, broad based gains with nearly all stocks and sectors benefiting. The "risk off" trade entails a flight to safety as investors flee risk assets for safe-haven investments such as U.S. Treasuries, gold, and the dollar. In this environment, the markets experience a sharp sell-off and all stocks and sectors experience losses. This investor behavior has led to stocks moving in lockstep and has made individual security selection a difficult task as stocks move more based on macro sentiment than underlying fundamentals.

A study recently conducted by Birinyi Associates underscores this spike in stock correlation. According to their study, the correlation among stocks in the Russell 3000 Index reached an all time high of 0.72 in July of 2010 and was at 0.63 entering October; well above its longer term average of 0.32.

Another factor contributing to the spike in correlation is the use of exchange-traded funds (ETF’s).

As the markets have become increasingly correlated and individual stock selection has proven challenging, investors have sought the use of ETF’s to make broad based bets on the financial markets. As ETF’s have grown in popularity, they are accounting for a larger share of daily stock-trading volume and are contributing to the market being driven more by macro sentiment than fundamentals. According to the 2010 Investment Company Factbook, the size of the ETF market has grown from 80 ETF’s and $66 billion in 2000 to 797 ETF’s and $777 billion in 2009.

As can be seen in the chart below, low quality stocks (B- and C based on S&P ratings) have consistently outperformed high quality stocks (A and A+ based on S&P ratings) since the beginning of 2009. This can be partly attributed to the use of exchange-traded funds as these passively managed funds buy into and sell out of broad based indices, which leads to erratic moves for the underlying securities, irrespective of fundamentals. Hedge funds seeking to generate gains in their short portfolios have found this to be an increasingly frustrating development as stocks with poor fundamentals continue to outperform as they benefit from investor flows into broad based investment vehicles.

S&P Ratings (see chart here: Source)

2011 and Beyond

“Concerns about the sovereign debt crisis and fears of a double dip recession, as well as other macro themes, have continued to dominate the investment landscape. The macro driven environment has made alpha generation difficult due to elevated levels of correlation among stocks.” said Mr. Gradante. “That said, we believe the current macro focus and high correlation is only temporary. Investment opportunities for hedge funds will increase as correlations revert to historical levels and stocks start to move in line with their fundamental values.”


(press release dated 26th October, 2010).

www.hennesseegroup.com


Bg

What do you think?

   Use "anonymous" as my name    |   Alert me via email on new comments   |   
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Americas - Australian banks sending U.S. hedge funds broke, Ryan Puerto Rico ‘rescue’ bill could be windfall for hedge funds[more]

    Australian banks sending U.S. hedge funds broke From SMH.com.au: US hedge funds are not having the best of years. Profits are hard to find, they're underperforming and the punters are losing patience, withdrawing US$15 billion ($20.8 billion) in the March quarter. They're expected to wit

  2. Investing - Billionaire Wilbur Ross likes the look of Chinese bad loans, Hedge funds are still relevant in a diversified portfolio: 4 fundamental criteria for superior manager selection[more]

    Billionaire Wilbur Ross likes the look of Chinese bad loans From Bloomberg.com: U.S. billionaire Wilbur Ross said he’s considering investing in nonperforming loans in China, as Moody’s Investors Service said that the nation has the tools to prevent a financial crisis in the near term. I’

  3. Investing - Blackstone gives pricey Canadian energy and property thumbs down, One of the most concentrated hedge fund bets is getting crushed, Facebook is hedge funds' new tech darling,[more]

    Blackstone gives pricey Canadian energy and property thumbs down From Bloomberg.com: Canada’s energy assets are uneconomic and real-estate markets overvalued, making them less attractive for investment than in the U.S. and elsewhere, according to Tony James, president of Blackstone Group

  4. Study - Only 30% of institutional hedge fund portfolios beat the benchmark[more]

    Bailey McCann, Opalesque New York: A new study from CEM Benchmarking, an independent provider of cost and performance analysis for pension funds, shows that only 30 percent of institutional investors hedge fund portfolios beat the benchmark after fees. The study provides in depth analysis of real

  5. Opalesque Exclusive: $1bn hedge fund club grows to 668 managers, continues to dominate (Part One)[more]

    Komfie Manalo, Opalesque Asia: Despite an underwhelming 2015 and a slow start to 2016 in terms of performance, one group of managers that continues to dominate the assets of the hedge fund industry is the so called $1bn club – hedge fund managers with at least $1bn in assets under management (AU