Hedge funds not bad at reading tea leaves finds new study
Oct 9th, 2008 | Filed under: CAPM / Alpha Theory, Today's PostAs we wrote in August, hedge funds seemed to be repositioning themselves for a down market. According to the Hennessee Group, average net (dollar) exposure had fallen from a high of around 55% in mid 2007 (the market peak) to 35% by mid 2008. Regardless of whether this means hedge funds can tel the future or not, shifting net exposure like that is obviously a useful skill. The mere fact that funds kept pushing down their net exposure does suggest some ability to read the tea leaves.
Now a new study seems to add credence to the argument that hedge funds have a statistically significant ability to time markets. Researchers from Citigroup and Athens University of Economics & Business found that there was a significant correlation between hedge fund market beta and market performance itself. In other words, hedge funds (specifically, “equity hedge” and “equity market neutral” hedge funds in the HFR database) became slightly more correlated with the market right before the market actually rose.
The authors set out to examine the behavior of three factors on hedge fund returns: value, momentum and “market”. But the market factor was the only one to show a significant relationship to future hedge fund returns.
As the table below shows, the correlation between the average market beta of hedge funds and the market’s returns is insignificant using the last month’s (”t-1″) market returns, is slightly higher using this month’s market returns and is relatively large (0.17) with next month’s returns. In other words, equity hedge funds seem to modestly ratchet up their market beta concurrent with rises in the market, but clearly ratchet up their beta in anticipation of a good month to come for the markets. Equity market neutral funds - although market neutral” also seem able to anticipate coming market “up months” (red circles below).
To continue reading this article please login (at the right) or click here to learn more about accessing our archives.
[…] recent struggles, hedge funds have done relatively well. Why? One recent study shows they can (despite academic claims that you can’t) reduce their exposure to market risk, […]
[…] recent struggles, hedge funds have done relatively well. Why? One recent study shows they can (despite academic claims that you can’t) reduce their exposure to market risk, […]