The Treasury’s new Office of Financial Risk (OFR) has concluded that hedge funds are really not the risk-prone investment vehicles they are commonly thought to be.
The OFR analyzed data, hitherto confidential, but made available to the OFR under the aegis of the Dodd-Frank Act, covering leverage levels, risk management and asset valuation practices of hedge funds.
“While these results are very preliminary, they seem to contradict the idea that hedge funds typically employ risky strategies,” said Richard Berner, stressing that the results were as yet tentative and based on only a preliminary analysis.
His findings were, understandably, welcomed by the Managed Funds Association, which said they corroborated its own view that “hedge funds currently do not pose a systemic risk.”
Hedge fund exposure and tail risks
Interestingly, these results are echoed in a recent study titled “Q3 2013 Hedge Fund Exposure & Tail Risk: Deconstructing Risk and Return Expectations and Stress Testing the 30 Largest Funds” conducted by eVestment Research Group’s Peter Laurelli and analysts Minkyu Michael Cho and Tony Kristic.
The study covered 30 hedge funds controlling over a third of a trillion US dollars in assets including medium grade (BBB/BB) US corporate debt, US fixed rate asset backed securities, global high grade (AAA) corporate debt and US equities with a bias towards large cap and growth characteristics.
The analysts performed historical stress tests to check the impact on the funds in the event a specific kind of historical catastrophe were to happen next month. It was comforting to find that a 1987 Black Monday type of event would find funds comfortably hedged against it. At the other end of the spectrum, the 2001 NASDAQ dotcom implosion would result in a loss next month of 2.29%.
“The worst expected portfolio return (if the 2001 NASDAQ Crash was to reoccur) is only -2.29%, which is significantly better than the -25.66% loss experienced by the NASDAQ from March 7 to April 4, 2001,” says the report.
Goldman Sachs says hedge funds curbed risk appetite in Q3
“We estimate hedge funds in aggregate operate 51% net long at the portfolio level, below levels earlier in the year despite the continued market rally. Risk appetite remained just below the record high of 53% set in 1Q and in line with leverage in 2Q. This stasis lies in contrast to the typical correlation between leverage and market performance as well as the continually climbing retail margin balance,” said the research note by Goldman Sachs Group Inc (NYSE:GS).