The top performing hedge funds year to date are Convertible Arbitrage, Emerging Markets, according to an October hedge fund performance report published by Credit Swisse prime brokerage unit. The worst performers are Managed Futures and Long / Short Equity, while none of the strategies outperformed the S&P 500, which is up 7.46% year to date. The interesting tale to be told, however, might be seen in correlation analysis.  What might be the most interesting tidbit … is that despite the death of alpha meme, according to the data from CS every major hedge fund category produced positive alpha over the past five years! See the chart below for those numbers.

Q3 2016 Hedge Fund Letters

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Convertible Arbitrage top performing strategy while Managed Futures, up earlier in the year, drags along the bottom

Convertible Arbitrage strategies are up 6.2% year to date with a fairly tight returns dispersion from top to bottom. Credit Suisse data shows the average bottom quartile fund average is positive by 4.3% while the top quartile fund is up 7.9%. By contrast, Managed Futures is down -5.4% year to date with a wide returns dispersion from -8.1% for the bottom quartile performers and -0.2% for the top quartile performers. Looking at returns from November 2013 to present, however, Managed Futures has been the top performer.

“Managed Futures have produced outsized Alpha relative to peers and as a percentage of total return while maintaining a limited exposure to the broader equity markets as measured by Beta and Correlation,” Connors wrote in a note attached to the document. Managed Futures Alpha was measured at 3.9% while Global Macro was closer in line with the hedge fund average alpha at 0.5%.  “However, the large, negative Kurtosis is a reminder that proper manager selection is paramount.”

Event Driven Risk Arbitrage and Emerging Market funds have the best 12-month rolling average performance, up 5.3% and 5.2% respectively. With a Sharpe Ratio of 2.31%, Credit Suisse’s Mark Connors noted the numbers were impressive on both an absolute and risk-adjusted basis. Emerging Market strategies, which had the highest upside distribution of returns, also had the highest beta and correlation to the S&P 500 “as alpha has been difficult to harvest for most funds and strategies since 2012.” During that same period Long / Short equity funds were the third best performer but generated 0.0% alpha, according to the report.

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Most hedge funds highly correlated with MSCI World stock index, negatively correlated to US treasury benchmark

Correlation to various beta benchmarks has typically been used as a method to model performance. The Credit Suisse report points to Emerging Market strategies having the highest correlation to the MSCI World stock index at 88.1%. The second highest correlation to the MSCI World is Convertible Arbitrage at 84.4%, while the least correlated is Managed Futures, the only negative correlation at -34.5%.

Other notable correlations to the MSCI World include the Hedge Fund general index at 74.1%, event driven strategies at 68.7% and Long / Short equity strategies a 71% positive correlation. While all those strategies sit near the top end of the correlation range, Global Macro, like managed futures, is only 12.6% positively correlated, while Event Driven risk arbitrage is only 26.3% positively correlated to the MSCI World.

With the oil markets being a source of hedge fund focus, it is the convertible arbitrage strategy that is most highly correlated to the price of oil, Connors notes.  “Energy’s influence on Converts and Emerging Markets is expected given that Energy is the largest segment of the high yield market,” he wrote. Like Emerging Markets, Distressed strategies also have a sensitivity to high yield markets. Managed Futures CTAs, by contrast, exhibited a negative correlation to oil due to their short positioning in 2014 and 2015.

The vast majority of the hedge fund strategies measured in the Credit Suisse report are negatively correlated to US Treasury prices, basis the Credit Suisse Liquid US Treasury Total Return benchmark. The highest correlations can be seen in Fixed Income Arbitrage, at 63.1%, which directly invests in those market. That said, Long / Short Equity hedge fund strategies are close behind at 62.2% while the general Hedge Fund Index is correlated at 44.2%. Managed Futures has a positive 74.6% correlation.

“Rates have been a major driver of profit and loss for Managed Futures / CTA managers since 2013,” Connors noted.  “The high correlation reflects this reality.  Profitability has been driven by the tenor of the ‘switching models employed, short, medium or long.”

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