{"id":190682,"date":"2023-05-19T10:45:00","date_gmt":"2023-05-19T14:45:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=190682"},"modified":"2023-05-19T10:46:59","modified_gmt":"2023-05-19T14:46:59","slug":"when-high-alpha-met-low-beta","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/macro\/when-high-alpha-met-low-beta\/","title":{"rendered":"When High Alpha Met Low Beta"},"content":{"rendered":"\n<p><strong>By&nbsp;Max Gelb&nbsp;and&nbsp;Jerry Tsai<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-summary\">Summary<\/h2>\n\n\n\n<ul class=\"wp-block-list\">\n<li>An in-depth analysis of hedge fund performance demonstrates that, over the past 15 years, lower-beta hedge fund styles have generally achieved higher alpha, aligning with investors&#8217; objectives of maximizing returns and diversification.<\/li>\n\n\n\n<li>Within the hedge fund landscape, multi-strategy, macro, and trend-following strategies have delivered meaningful alpha while maintaining lower exposure to traditional market betas.<\/li>\n\n\n\n<li>The persistence of heightened market volatility may further extend this long-term trend, increasing the appeal for hedge fund strategies that offer the potential for both meaningful defensiveness and alpha.<\/li>\n<\/ul>\n\n\n\n<p>More specifically, investors have historically tended to seek low beta strategies to diversify traditional asset classes and high alpha approaches in seeking to generate significant excess returns after controlling for traditional market exposures. Although many may assume a trade-off between alpha and diversification potential, that hasn\u2019t been the case: Over the past 15 years,&nbsp;<em>lower-beta&nbsp;<\/em>hedge fund styles have realized&nbsp;<em>higher&nbsp;<\/em>alpha.<\/p>\n\n\n\n<p>There are many potential explanations for this counter-intuitive result and each strategy has its own story (see our&nbsp;<em>Featured Solution&nbsp;<\/em>from March, \u201cModern Macro,\u201d for a deeper dive). However, one pattern that emerges is that strategies with stronger \u201ccrisis alpha\u201d during equity market drawdowns \u2013 precisely the scenario investors fear today if recession strikes \u2013 have also generated the highest long-term alpha.<\/p>\n\n\n\n<p>Hedge fund strategy performance in 2022 provides the latest striking example. In 2022, while broad hedge fund indices declined 4.1% and $55 billion of capital fled the industry,<sup><a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/when-high-alpha-met-low-beta#fn-1\">Footnote1<\/a><\/sup>&nbsp;lower-beta strategies such as multi-strategy, macro, and trend-following delivered positive performance and much-needed diversification.<\/p>\n\n\n\n<p>Widening the aperture, hedge fund industry assets have doubled from $1.9 trillion in 2007 to $3.8 trillion today, despite cumulative net flows of only $42 billion. In other words, hedge fund assets have seemingly grown steadily thanks primarily to long-term performance, but investors need to look under the hood to evaluate which strategies are driving the growth and where capital is flowing. For example, long\/short equity has shrunk from 37% to 28% of hedge fund assets since 2007, whereas relative value, macro, and event-driven categories have all grown.<\/p>\n\n\n\n<p>Looking forward, many investors are asking which hedge fund styles are more likely to prosper in an environment of heightened volatility and prolonged higher interest rates to combat inflation (see our&nbsp;<em>Cyclical<\/em>&nbsp;<em>Outlook<\/em>&nbsp;from April, \u201c<a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/fractured-markets-strong-bonds\">Fractured Markets, Strong Bonds<\/a>\u201d).<\/p>\n\n\n\n<p>Our framework for evaluating the historical performance of underlying strategies helps explain these trends. As in 2022, periods of high volatility have often coincided with stock market weakness \u2013 punishing hedge fund strategies with higher equity beta relative to lower-beta strategies including trend-following and macro.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Winning on both fronts: Positive alpha and increased diversification<\/h2>\n\n\n\n<p>The appeal of hedge funds has generally relied upon alpha generation and diversification from traditional asset classes. These are easily quantified with a simple model that regresses hedge fund returns against four major asset classes (equity, interest rates, credit, and commodities). The results show what proportion of a hedge fund\u2019s historical returns is explained by traditional betas versus alpha.<\/p>\n\n\n\n<p>It turns out that over the 15 years ending December 2022, strategies with lower beta to traditional markets \u2013 such as multi-strategy, macro, and trend-following \u2013 have also&nbsp;generated higher alpha (see Figure 1). This is a compelling \u201cdouble-whammy\u201d for allocators. Moreover, these results highlight the potential danger of evaluating hedge funds based on&nbsp;<em>total&nbsp;<\/em>returns alone. For example, a higher-beta strategy may have a greater&nbsp;<em>total&nbsp;<\/em>return than a lower-beta strategy during a bull market, but the&nbsp;<em>composition&nbsp;<\/em>of the lower-beta strategy\u2019s return may have significantly more alpha. In a total portfolio context, investors are&nbsp;understandably unwilling to pay hedge fund fees for returns that can be replicated in traditional liquid markets.<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"523\" height=\"664\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig1.png\" alt=\"lower-beta diversifying strategies have realized higher long-term alpha\" class=\"wp-image-190684 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig1.png 523w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig1-300x381.png 300w\" data-sizes=\"(max-width: 523px) 100vw, 523px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 523px; aspect-ratio: 523\/664;\" \/><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\">Cyclical outlook favors lower-beta diversifiers<\/h2>\n\n\n\n<p>For investors reconsidering their hedge fund allocations, we believe it is critical to assess how the risk of elevated volatility and interest rates could affect various hedge fund strategies. As Figure 2 shows, lower-equity-beta strategies such as trend-following and macro (which had betas of -0.10 and 0.07 since December 1999, respectively<sup><a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/when-high-alpha-met-low-beta#fn-2\">Footnote2<\/a><\/sup>&nbsp;) have done better in periods of high volatility when stocks tend to struggle. In addition, trend-following and macro have outperformed during higher cash-rate regimes \u2013 likely, in part, because&nbsp;those strategies have more unencumbered cash available to invest at higher market rates.<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"991\" height=\"698\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig2.png\" alt=\"lower-beta strategies have outperformed in high volatility and high interest rate regimes\" class=\"wp-image-190683 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig2.png 991w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig2-700x493.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig2-300x211.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/PIMCO_Viewpoint_Gelb_Tsai_May2023_Fig2-768x541.png 768w\" data-sizes=\"(max-width: 991px) 100vw, 991px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 991px; aspect-ratio: 991\/698;\" \/><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\">Follow the trend<\/h2>\n\n\n\n<p>The data indicate that the composition of investor hedge fund portfolios is changing \u2013 and for good reason. Investors are discerning about where they will pay hedge fund fees, and are gravitating toward styles that are hitting on both alpha and diversification objectives. Elevated volatility and interest rates may prolong this long-term trend, increasing the demand for strategies with superior defensiveness and alpha potential.<\/p>\n\n\n\n<p><sup>1<\/sup>\u00a0Performance proxied by the HFRI Fund Weighted Composite Index and flows proxied by total industry data from HFR.\u00a0<a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/when-high-alpha-met-low-beta#fn1-base\">Return to content<\/a><\/p>\n\n\n\n<p><sup>2<\/sup>\u00a0Proxies: Trend-following = SG Trend Index; macro = HFRI Macro Index\u00a0<a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/when-high-alpha-met-low-beta#fn2-base\">Return to content<\/a><\/p>\n\n\n\n<p>&#8212;<\/p>\n\n\n\n<p>Originally Posted May 18, 2023 &#8211; <a href=\"https:\/\/www.pimco.com\/gbl\/en\/insights\/when-high-alpha-met-low-beta\">When High Alpha Met Low Beta<\/a><\/p>\n\n\n\n<p><strong>Disclosures<\/strong><\/p>\n\n\n\n<p><strong>Past performance is not a guarantee or a reliable indicator of future results.<\/strong><\/p>\n\n\n\n<p><strong>All investments&nbsp;<\/strong>contain risk and may lose value.&nbsp;<strong>Hedge fund and other alternatives strategies&nbsp;<\/strong>involve a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. Performance could be volatile; an investment in a fund may lose money.<\/p>\n\n\n\n<p><strong>Beta&nbsp;<\/strong>is a measure of price sensitivity to market movements. Market beta is 1.<\/p>\n\n\n\n<p>The&nbsp;<strong>correlation&nbsp;<\/strong>of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility.<\/p>\n\n\n\n<p>There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.<\/p>\n\n\n\n<p>The&nbsp;<strong>HFRI Equity Hedge Index&nbsp;<\/strong>is an unmanaged index that consists of a core holding of long equities hedged at all times with short sales of stocks and\/or stock index options. Some managers maintain a substantial portion of assets within a hedged structure and commonly employ leverage. Where short sales are used, hedged assets may be comprised of an equal dollar value of long and short stock positions. Other variations use short sales unrelated to long holdings and\/or puts on the S&amp;P 500 index and put spreads. Conservative funds mitigate&nbsp;market risk by maintaining market exposure from zero to 100 percent. Aggressive funds may magnify market risk by exceeding 100 percent exposure and, in some instances, maintain a short exposure. In addition to equities, some funds may have limited assets invested in other types of securities.The&nbsp;<strong>HRFI Macro Index&nbsp;<\/strong>is an unmanaged index that involves investing by making leveraged bets on anticipated price movements of stock markets, interest rates, foreign exchange and physical commodities. Macro managers employ a \u201ctop-down\u201d global approach, and may invest in any markets using any instruments to participate in expected market movements. These movements may result from forecasted shifts in world economies, political fortunes or global supply and demand for resources, both physical and financial. Exchange-traded and over-the-counter derivatives are often used to magnify these price movements. The&nbsp;<strong>HRFI Relative Value Arbitrage<\/strong><strong>&nbsp;Index&nbsp;<\/strong>is an unmanaged index that attempts to take advantage of relative pricing discrepancies between instruments including equities, debt, options and futures. Managers may use mathematical, fundamental, or technical analysis to determine misvaluations. Securities may be mispriced relative to the underlying security, related securities, groups of securities, or the overall market. Many funds use leverage and seek opportunities globally. Arbitrage strategies include dividend arbitrage, pairs trading, options arbitrage and yield curve trading. The&nbsp;<strong>Credit Suisse Liquid Alternative Beta &#8211; Multi-Strategy Index&nbsp;<\/strong>reflects the combined returns of the individual LAB strategy indices \u2013 Long\/Short, Event Driven, Global Strategies, Merger Arbitrage and Managed Futures \u2013 weighted according to their respective strategy weights in the Credit Suisse Hedge Fund Index. The&nbsp;<strong>SG Trend<\/strong><strong>&nbsp;Index&nbsp;<\/strong>calculates the net daily rate of return for a group of 10 trend following CTAs&nbsp;selected from the largest managers open to new investment. The SG Trend Index is equal-weighted and reconstituted annually and has become recognized as the key managed futures trend following performance benchmark.<\/p>\n\n\n\n<p>It is not possible to invest directly in an unmanaged index.<\/p>\n\n\n\n<p>This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is not possible to invest directly in an unmanaged index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.<\/p>\n\n\n\n<p>PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. |&nbsp;<strong>Pacific Investment Management Company LLC<\/strong>, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. |&nbsp;<strong>PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom)&nbsp;<\/strong>is authorised&nbsp;and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. |&nbsp;<strong>PIMCO Europe GmbH (Company No. 192083,&nbsp;<\/strong><strong>Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963, Corso Vittorio Emanuele II, 37\/Piano 5, 20122 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain) and PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. 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The Italian Branch, Irish Branch, UK Branch, Spanish Branch and French Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Societ\u00e0 e la Borsa (CONSOB) (Giovanni Battista Martini, 3 &#8211; 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN);&nbsp;(4) Spanish Branch: the Comisi\u00f3n Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law&nbsp;on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217\/2008, respectively and (5) French Branch: ACPR\/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014\/65\/EU on markets in financial instruments and under the surveillance of ACPR and AMF. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. |&nbsp;<strong>PIMCO (Schweiz) GmbH (registered in Switzerland, Company<\/strong><strong>&nbsp;No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland)<\/strong>. The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. |&nbsp;<strong>PIMCO Asia Pte Ltd&nbsp;<\/strong>(Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. 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PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. <sup>\u00a9<\/sup>2023 PIMCO.<\/p>\n\n\n\n<p>CMR2023-0509-2894911<\/p>\n","protected":false},"excerpt":{"rendered":"<p>A closer look at performance across hedge fund styles.<\/p>\n","protected":false},"author":186,"featured_media":190683,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[18,6,8,9,26,3],"tags":[712,420,305],"contributors-categories":[13620],"class_list":{"0":"post-190682","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-macro","8":"category-north-america","9":"category-region","10":"category-securities","11":"category-text-articles","12":"category-traders-insight","13":"tag-alpha","14":"tag-beta","15":"tag-diversification","16":"contributors-categories-pimco"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v27.4) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>When High Alpha Met Low Beta | 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