How Hedge Funds Perform When the VIX is High

In a recent article  published in the Alternative Investment Analyst Review, Mikhail Munenzon, CFA, CAIA, PRM and Director of Asset Allocation and Risk at the Observatory, researched how different hedge fund strategies performed during periods of volatility over twenty years.  The data came from the Center for International Securities and Derivatives Markets Indices.  The strategies covered were convertible arbitrage, distressed, merger arbitrage, commodity trading advisor, macro, equity long/short, equity market neutral, emerging markets and event driven.  He looked at the indices for traditional assets too:  S&P 500 Index, JPM Morgan Aggregate Bond Total Return Index, SP GSCI Commodities Index and the FTSE EPRA/NAREIT US Total Return Index, a real estate index. Volatility was measured by the VIX index from 12/31/91 to 1/29/10.  Munenzon created six categories:  less than 20, 20-25, 25-30, 30-35, 35-40 and more than 40.  The VIX was under 30 90% of the time and under 20 50% of the time.  Based on the data, it does not jump randomly from being quiet to being volatile.  They remain calm or volatile at times and remain so for the near future.  Each index's return was analyzed during the same timeframe.  Here are the most important points:

• Only four of fourteen indices had positive returns in all conditions:  commodity trading advisor, macro, equity market neutral and JPM Morgan Aggregate Bond Total Return Index
• Superior long term performance of hedge funds are due their ability to limit their losses during times of market stress due to unconstrained investing.
• This affirms an earlier study by Welton Investment Management stating that macro and commodities are the two strategies that are not correlated with the stock markets

Please note that data is based on indices.  Individual portfolios of funds may have different results.