Monday, January 25, 2010

Best Performing Hedge Fund Strategies This Past Decade

Based on the HFR indices, here are the top hedge fund strategies over the past decade. We can note that converts have had bad years but were top performers on exit of recessions (2002, and 2009). Distressed investing shows a similar pattern (#3 in 01 and 03 and #1 in 2004, then #4 in 2009). Emerging markets have been consistently good performers these past few years, except in 08. Systematic strategies have done very well in the second half of the decade, even in 2007 despite August of that year; of course, last year is an exception due mostly to trend followers.

(click on chart to enlarge. Source: dataforthoughts)

Palladium and Copper Retraced

Palladium and copper came back in line with their linear historical relationship. The palladium contract was at $462 on 1/20, as indicated in the white panel, and as of Friday had lost about $20, while the copper futures had barely budged.

Butterfly Retraced Friday

Here's the same butterfly as of early afternoon Friday. The reason the downside peak we had seen on a previous post does not show up is simply that this chart shows only market-close levels.

Thursday, January 21, 2010

Butterfly on 1-Month Options on Mid-Term Swaps

The 50:50 fly on 1-month options on 1-, 2- and 5-year swaps is current 2.7 standard deviations from its 1-year average.

Palladium and Copper

March contracts on palladium and copper at 0.8 std devs from their regression line.

Thursday, January 7, 2010

Follow-Up on RYL v. KBH

Since my post of the pair trade long KBH/short RYL, KBH jumped 14.4% from $13.80 to $15.80 while RYL increased 6.8% from $20.50 to $21.90. With a hedge ratio of 0.88, the gain is $2*0.88 - $1.4 = $0.36 per share shorted.

The Lost Decade of Equities - What About Hedge Funds?

The quick study that follows looks at the past decade (from 1/1/00 to 12/31/09), and compares the total returns of a balanced portfolio of classic asset classes with that of a basket of hedge funds. (I used the HFR Weighted Composite Index as a proxy for a well diversified basket of HFs.)

The "classic" portfolio I picked consists of:
  • US Large Cap (Total return on the S&P500), with a weight of 30%
  • Global Equities (S&P Broad Market Global TR Index), 20%
  • U.S. Corporate bonds (JPM U.S. Aggregate Bond TR Index), 20%
  • U.S. Government Bonds (Merrill Lynch 10-year U.S. Treasury Futures TR), 20%
  • Commodities (Merrill Lynch Commodity Index TR), 10%
The table below shows the values, normalized to begin the decade at 100, of the different asset classes (indices), together with that of the HF index and that of the classic portfolio described above.



On a non-risk-adjusted basis, the basket of HFs does just a bit better than the classic portfolio. We also note that commodities had a phenomenal run, and that equities of all sorts indeed had a lost decade. Now, if we adjust for risk, we can see that the HF index does considerably better. In the graphs below, we add to the classic portfolio a varying dose of the HF index: 0% corresponds to the pure classic portfolio, and 100% is the HF index alone.

The first graph plots annualized returns against standard deviation of monthly returns:



Surprisingly, the HF index beats the portfolio by about 1 p.p., on average, each year, for a much lower volatility. If we look at Maximum Draw Down as another measure of risk, we get the same result:



In conclusion, despite the turmoil of 2008 and 2009, institutional investors will probably (and should) maintain a healthy allocation to hedge funds.

An Indirect Impact of the Housing Burst on the Economy: Through Workforce Immobility

I keep hearing that the low mobility of people between European countries is a challenge to the Euro zone. Now it looks like the U.S. may be suffering from the same issue, due to the extremely poor liquidity of residential real estate.

In a Bloomberg article today: "The ability to relocate for employment, which helped the U.S. recover quickly after previous deep recessions, is the latest victim of the housing bust. About 12.5 percent of Americans moved in the year ended March 2009, the second-lowest ever, estimates Brookings Institution demographer William Frey, after a 60-year record low of 11.9 percent the previous year."

The impact on the economy is not just theoretical. In the same article: "The stagnant workforce may raise the long-term trend rate for unemployment by 1 percentage point and lower economic growth 0.3 percent a year through 2012, said Michael Feroli, an economist in New York for JPMorgan Chase & Co. It has already contributed to keeping the jobless rate as much as 1.5 percentage points higher than would have been suggested by the depth of the recession, Peter Orszag, director of the U.S. Office of Management and Budget, estimated in July."