New York (HedgeCo.net) Last month we featured a story entitled Lack of Correlation Apparent Over Long Run. Since publishing that article, more articles have come to our attention mentioning or focusing on correlation. One particular article was from ValueWalk and the article focused on a report from Goldman Sachs. One particular statement in the article got our attention.
“The oddity is that hedge funds in general are correlated to stocks by a magnitude of nearly 0.80 depending on the indexes being compared.”
The thing that jumped out was the claim that hedge funds have a correlation of 0.80. That seemed extremely high, so we set out to test that claim. Just to refresh everyone’s memory, correlation measures how much of an investments return can be attributed to the return of the overall market. In most cases, correlation is measured by using the S&P 500. In the case of a correlation of 0.80, this would mean that 80% of the returns from hedge funds could be attributed to the returns of move in the market as a whole, as measured by the S&P 500.
Something else you have to remember is that the correlation will change over time and it will be different during different time periods. What we did was take the Credit Suisse Hedge Fund Index (CSHFI) and measure the correlation against the S&P 500 SPDRs (SPY). Using the Spyders allows us to see the return of the S&P including the dividends captured over time.
Going back to January 1993 and looking all the way up through August, the correlation of the CSHFI to the SPY is 0.57. That is a long way from 0.80. Looking at certain time periods over the last 15 years, from 2000-2015 the correlation sits at 0.60 and that is up from 0.54 from 2000 to 2010.
As an investor, what you really want is for the correlation to high when the market is moving higher and the correlation to be low when the market is moving lower. Has the CSHFI done this over the years? During the bear market from October 2007 through February 2009, the correlation of the CSHFI was 0.60. A little higher than you would really want, but still better than 0.80. From the low in 2009 through the end of August, the correlation for the CSHFI stands at 0.80, which is what you want since the market has been in a bullish phase over this period. Looking at one more bearish phase, from January 2000 through September 2002 the correlation was at 0.27. That is what you really want, a very low correlation during a bearish phase.
Looking at the fund manager models on the HedgeCoVest platform, the average correlation is 0.57 as of September 17. If you recall, that was the same correlation for the CSHFI from 1993 through the present. Only three models on the platform have a correlation over 0.80. If you are looking to build a portfolio using multiple models, you can use the correlation calculations to balance out your portfolio. If one model you want to invest with has a high correlation, you may want a model with a low correlation to balance it out.
Rick Pendergraft
Research Analyst
HedgeCoVest
