GLOBAL - The correlation between hedge funds and share markets has returned to highs not seen since before the financial crisis, causing potential concern for investors seeking diversification.
The one year rolling correlation of hedge funds to the S&P 500, Dow Jones Stoxx 50 and MSCI World is higher now than at any time since mid-2007. For each index, the correlation is above 85%.
Hedge funds, as represented by the Dow Jones Credit Suisse Hedge Fund index, have not been as highly correlated to the DJ Stoxx 50 and MSCI World indices for four years and 16 years for the S&P.
Only Japan's Topix has bucked the high correlation trend recently, with long/short portfolio correlation to the benchmark hitting a six-year low of 4.5% in February, although it has slowly climbed since.
Sameer Saifan, head of quantitative research and risk analysis at fund of funds Stenham, says the high correlation to the S&P occurred as the US dollar became the major funding currency for carry trades.
"The common trade is to go short the US dollar, and invest in any global risky
asset, hence risky assets have moved in synchronisation with each other across the globe," he said.
The correlation could be a cause for concern among investors who use hedge funds as a cushion against market falls, but managers said it should not cause undue alarm.
Tim Gascoigne, head of portfolio management at HSBC Alternative Investments, which manages about US $4.5bn, said: "When markets move upwards for some time hopefully hedge funds will correlate. It is when they become more mixed you would hope correlation will drop.
"For trend-following funds, if you have nine to 10 months of upwards trends in markets it is natural a trend-following system will follow that.
"Also, some strategies are naturally long-biased, like distressed assets [strategies], so there are a number of reasons why there is this correlation. If you see two to three months of the markets we saw in May, hopefully the correlation will come down."
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