It May Finally Be Hedge Funds’ Time to Shine

Global macro hedge funds shouldn’t behave like a health care portfolio. But recently every strategy has been acting the same, leaving investors with little of the diversification that hedge fund managers promise.

That’s beginning to change as correlations come off their highs, according to a study expected to be released Monday by research and hedge fund data firm PivotalPath.

“You have these risk factors that are all correlated,” Jonathan Caplis, CEO of PivotalPath, said in an interview. “That’s concerning. That means everyone is investing in the same type of risks.”

Over the last two months, however, Caplis said risk factors have become less correlated. “Now, we’re seeing green shoots,” he said. “If there is more dispersion among risk factors, that means that hedge fund managers should be able to find different types of risks to trade.” 

As an example, Caplis explained that health care strategies typically have a 0.7 correlation to the PivotalPath Hedge Fund Composite Index, a comprehensive index representing over $2 trillion of assets. The higher the number, the more correlated the strategies are. Health care’s correlation peaked earlier this year at 0.9, then more recently dropped to 0.84. Now it’s at 0.71, in line with historical figures.

“That’s healthy,” Caplis said. “Health care shouldn’t trade as energy or event-driven [strategies] would. If the fundamentals are driving price, you should see a lot of dispersion.”

Correlations among hedge fund strategies have recently been at levels not seen since the global financial crisis. For investors, everything acted the same, whether they were in technology, health care, global macro, commodities, event-driven or any other strategies around the world. 

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Dispersion is particularly important in the long-short equity category, which represents a majority of hedge fund assets, according to PivotalPath.

“That [category] needs to have dispersion in order for managers to pick companies that are rising and sell the companies that aren’t rising as quickly or not at all,” Caplis said. “But if every stock goes up in lock step, your long-short portfolio won’t do anything, depending on leverage and other factors.”

According to the report, what investors should take away from falling correlations and higher dispersion is that manager selection is “incredibly important” and can result in “substantial differences in performance.”

“It’s a nascent shift in global correlation going into 2020,” said Caplis.