Abstract
The golden times of the hedge fund industry ended with the beginning of the financial crisis of 2007/08. Since then hedge funds have underperformed against the S&P 500. This study shows that the Dodd Frank Act regulation was responsible for a completely changing environment for hedge funds. We have developed a model where equity indices and the CRB index are explanatory variables for hedge fund performance. Concerning methodology, data of two different phases are considered, namely the time period from 1990 to July 2010 (implementation of Dodd Frank Act) and the time period from August 2010 to April 2015. Surveys for the second time period showed that regulation was a major issue for the hedge fund industry. Especially small hedge funds find it problematic to get leverage from prime brokers and capital from investors. Another trend shown with the surveys is a general increase in the long only strategy (especially of small hedge funds). Our hypothesis assumes that the explanatory character of the MSCI Emerging Market (MSCI EM), the S&P 500, and the CRB index for hedge fund performance is increasing in the second period. The hypothesis is found to be correct.
Highlights
The main target of hedge funds is a procyclical positioning on financial markets, which means that, hedge funds should be net long risky assets in upswings on equity markets and be net short risky assets during downswing periods [1]
The data show the relative weakness of the CRB and the MSCI in the second time period
It can be seen that the relative performance of hedge fund strategies in comparison to S&P 500 was very strong until July 2010
Summary
The main target of hedge funds is a procyclical positioning on financial markets, which means that, hedge funds should be net long risky assets in upswings on equity markets and be net short risky assets during downswing periods [1]. With that strategy the target of an Absolute Return Fund should be achieved. This does not mean that the correlations between the hedge fund returns and the risky assets should be zero because the upswing periods are very long and the downswing periods are relatively short. Studies on correlations between equities and hedge fund returns show that the correlations are not stable over time but are increasing in upswing periods. The studies discussed below focus on different aspects of hedge fund performance
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