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This Hedge Fund Of Funds Beat The S&P500

Hedge funds were invented as a way to diversify investor portfolios and to better manage risk (by “hedging”), but the bull run in equities in the past decade has “converted” many to long only exposure one way or another, as if there is no choice but to be long equites if one wants to achieve decent performance. The diversifying nature of hedge funds isn’t just supposed to be to equities, however, so this week we wanted to try and see if we can find such funds that have negative correlation to other indices - not just equity markets - and that have decent performance. We used the NilssonHedge database, which contains mainly CTAs and long/short equity hedge funds, and is available on AlphaBot, to try and find out.

To make it interesting, we ran more than 3,000 programs through the Quant Screener to find those that have low correlations to equities - namely the S&P500; CTAs - in  this case the Barclay CTA index - and bonds, for which we're using the ICE U.S Treasury Core Bond TR Index. We used a reasonable threshold of -0.15 correlation level. To ensure comparable results, we also require the returns for every month in the past 3 years (2017-2019). Note that we do not impose any requirements on performance, only correlation, as it is quite easy to find programs that have been doing well in the past, but it is not our objective here. The Sharpe ratio, while calculated for information purposes, is not being filtered in any way.


We found only 11 programs which met each of our criteria, of which ten exhibited very impressive negative correlations to all 3 indices AND impressive Sharpe ratios.


So what can we do with a set of programs like that?  We can build a portfolio, of course, and see how it behaves. For simplicity, we use equal weights, and then compare the result with the S&P and CTA indices on risk-adjusted basis, and we find that our little portfolio has outperformed the S&P500 in the past 3 years!


This is not bad at all considering that we used a relatively simple process. Those statistically inclined will also notice some pretty good stats this portfolio is demonstrating vs the indices, including a solid Sharpe and a negative correlation to both stocks and CTAs.


Finally, with more than 3,000 CTAs and hedge funds to pick from it is quite possible to find many other programs - and combinations of programs - that deliver interesting return profiles. The tools and the data are readily available, so “screen away!”

Dmitri Alexeev is Founder and CEO of AlphaBot, a collaborative platform for alternative investment research.


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