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How Have Hedge Funds Begun H2 2019?

I’m Dmitri Alexeev, Founder of AlphaBot, a technology platform based in Chicago, which helps investment industry professionals to dramatically cut the time it takes to perform investment research and modeling, to connect with investors, and to reach out to new clients. During my career, I’ve been a Director of Research and IT at HFR Asset Management, Senior Analyst at Man Group, and the CIO of hedge fund Dearborn Capital Management. I launched AlphaBot because I believe that there is an opportunity to help clients speed up their alternative investment research - up to a factor of 10x. Previously, working with alternative investment data can be cumbersome. It requires expensive custom tools or databases, multiple spreadsheets and a lot of time. AlphaBot combines data sourcing, management, analytics and document management and sharing functions into one efficient and consistent interface allowing clients to focus on research instead of infrastructure.

Most weeks, I’ll be blogging on AlphaWeek’s Side Pocket and using AlphaBot to create some interesting charts, graphs and data for AlphaWeek readers. I can be reached at dalexeev@alphabot.net.

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For my inaugural post on Side Pocket, I’m going to review the performance of a few major hedge fund indices for the first half of 2019 and try to take a glimpse into how these strategies have begun the second half of the year. To do that, I use a combination of the BarclayHedge CTA and Hedge Fund indices as well as Macro and Trend-Following indices from MSR, a provider of factor-based, investable daily indices. While major Hedge Fund and CTA indices are produced monthly, the MSR indices, constructed using futures contracts, are produced daily, and therefore we can get an insight into daily industry dynamics, well before monthly data becomes available. We will also use the traditional S&P 500 equity index, given its widespread use as a benchmark.

We can build a proxy for each hedge fund index using the daily MSR indices to try and forecast the July result of monthly CTA and HF indices. Using the Factor Decomposition tool in AlphaBot, we build a portfolio from MSR’s Macro and Trend-Following indices as well as the S&P 500 that catches the monthly indices dynamics pretty close for the current year. It is an approximation, of course, and the fit is not perfect, but it makes the exercise very interesting if we will be able to predict the monthly indices value using daily ones. We will cover the process of building proxies or using the factor decomposition tool in greater detail in future posts.

Taking a look at the VAMI chart that combines data for MSR, BarclayHedge, S&P500, and our proxy indices (monthly lines for BarclayHedge appear stepwise on daily scale), the first thing that stands out in H1 is no surprise - the dominance of equities (S&P 500) over the hedge fund indices.

AlphaBot

At the same time, it’s nice to see that hedge funds are also able to produce positive YTD returns. A pretty tight clustering of returns for the asset class also stands out, confirmed by the very high correlation of hedge funds to the S&P 500 for the first half of 2019:

AlphaBot

From this standpoint, performance of major hedge fund indices is following the pattern that has been typical for the last few years - having a high correlation to equities while producing a fraction of equities’ returns. The CTA indices have lower correlation to equities but achieve even lower returns. There are a number of possible explanations for this effect and we plan to explore this subject in future posts.

With this picture in mind for the first half of 2019, is there anything we can infer from the daily performance of our proxies built from MSR factor-based indices? Let’s take a closer look at returns available month-to-day (at the time of publication):

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What we see in July is consistent with recent history. Equities are trending higher, pushing through any temporary pull-backs, and both Macro and Trend Following indices are struggling to keep up. They still manage to stay in positive territory, however. Consistency of this performance pattern gives us enough confidence to expect it to continue through the end of the month, and quite likely much longer, through the end of the year. Additional volatility in equities can easily break the positive returns generated by alternatives so far, unless a really strong and persistent bearish trend begins to dominate the equity space. In that case, hedge funds may once again get a chance to show off the diversification that is a significant part of their raison d’etre.

So what about forecasting monthly Hedge Fund and CTA indices? If the last few trading days of the month raise the S&P 500 another percentage point to close at about 4% for the month, we would expect the Hedge Fund index bring about returns of approximately 1.5% and the CTA index around 1%. Once July is over the month completes we’ll publish an update, and then compare it to actual returns posted by BarclayHedge when they become available in the first half of August.

Dmitri Alexeev is Founder and CEO of AlphaBot