Hedge Fund Performance During and After the Financial Crisis

Using a large database of over 9500 hedge funds available from the Hedge Index, performances of ten major strategies, during and after the financial crisis, were investigated in this study. After visual inspection, the ten-year data-sample was divided into two sub-periods (June 2007–March 2009 and April 2009–January 2017) and was analysed for correlations, risk and return, persistence in performance, return attribution using Carhart's four-factor model and reward-risk ratios.

Analysis with Carhart's model, showed that no strategy was able to produce a significant alpha during the financial crisis. It became obvious that the market was not the most efficient during the financial crisis, though it might well have been so, in the after-crisis period when the S and P 500 was the best performer. During the financial crisis, each hedge fund strategy offered risk-adjusted performance that was superior to the S and P 500's risk-adjusted performance. After the financial crisis, although four strategies (Convertible Arbitrage, Fixed Income Arbitrage, Multi Strategy and Global Macro) were able to outperform the S and P 500, in risk-adjusted terms, in absolute terms, the S and P 500 was the best value performer.

All strategies did better than the benchmark S and P 500, during the crisis, and over the whole period, seven strategies did better than the benchmark S and P 500 (Convertible Arbitrage, Emerging Markets, Event Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity, Multi Strategy). This meant that, for an investor, it is important to forecast downturns for a continued better performance than the benchmark S and P 500.

All this brings up an evaluation of whether hedge funds deliver better value for investors, which was one of the main aims of the current research. Correlations of various hedge fund strategies with the benchmark S and P 500, showed different behaviour in the during -crisis period versus the after-crisis period; the correlations of Emerging Markets, Equity Market Neutral, Global Macro, Long/Short/Equity and Multi Strategy and Managed Futures, increased in the after-crisis period; the strategies which showed a fall in correlation with benchmark S and P 500 in the after-crisis period, were the Convertible Arbitrage, Fixed Income Arbitrage and the Shortbias. The Carhart Model provided tremendous insights on which strategies generated positive alphas, the extent of market risk, strategies have, or had advantageous attributions to the SML, HML and UMD factors. Strategies which generated significant positive returns were related to a better overall performance, though none of the strategies were able to persistently perform better than the S and P 500, in a rising market. Of the reward-risk ratios, the Sortino ratio appeared to be the most reliable, as strategies ranked in this way, within a downside risk framework were significantly correlated with the ranking of performances of the strategies, either over the whole period, or during or after crisis. In falling markets, Short Selling and Managed Futures had a clear advantage for opportunities of better returns, just as in rising markets, Convertible Arbitrage and Fixed Income Arbitrage do. In rising markets, Managers of these strategies see ‘arbitrage opportunities' through shorting shares for the related convertible, or locating underpriced bonds, as the yield curve changes are brought on by Central Bank interventions; though, of course, these are still speculative, under the strict definitions of ‘arbitrage', as they bet on a rising market or increasing interest rates. By definition, Short Selling and Managed Futures result in a better predictable outcome than the benchmark, only in falling markets.

If hedging is about hedging against market risk (i.e., the risk of the S and P 500), all strategies did better than the S and P 500, in the crisis period; thereby, better conserving value for investors over passive investment in the S and P500. Global Macro with its top-down approach, and Multi Strategy, Long/Short Equity and Event Driven, with their active strategies, appeared to be the best performers. Emerging Markets was the fourth best performer over the whole period and also did better than the S and P 500 by offering diversification and risk reduction (higher Sharpe and Sortino ratios in the crisis and whole periods). However, over the whole period, only Global Macro and Multi Strategy had superior performances with positives alphas, and lowest positive correlations with the S and P 500, through active exploitation of opportunities, either in the same or alternative markets than the universe of the S and P 500.

Unlike previous studies, the conclusions of this research are that hedge fund strategies can generate superior returns over passive investments in the Market Portfolio (proxied by the S and P 500), particularly in crisis times, and depend on Investors' ability to forecast and select the appropriate strategy for that time. Furthermore, the downside risk framework is superior to the conventional one for evaluating reward-risk characteristics of Hedge Fund strategies.