The effect different investment strategies have upon returns : examining the characteristics of the main investment strategies employed by funds, measuring their risk exposure and risk adjusted returns, and analysing whether the fund returns are correlated with the market

Abstract

This study investigates the performance of various strategies in comparison with the market benchmark, S&P500 index. Their risk and return relationship is evaluated relative to a market benchmark over a 12-year period from January 2006 until December 2017, thus capturing different market conditions. In line with financial literature, the findings of this dissertation show that the majority of the hedge funds return distributions are negatively skewed and have a positive excess kurtosis (leptokurtic). Based on absolute returns, the only instance that all strategies under analysis were able to outperform the market is during the crisis period, except for convertible arbitrage. However, since the S&P500 positive returns came with a corresponding high volatility, when assessing its performance based on risk-adjusted terms, the S&P500 was not able to keep its top-ranking position during the whole period, pre-crisis and after the crisis period. Macro/CTA and merger arbitrage strategy were able to generate a positive return and outperform the market during the crisis period based upon both absolute and risk-adjusted term. During the whole period, pre-crisis and after the crisis period, merger arbitrage has again generated a positive return and outperformed the market on risk adjusted terms, making it a contender across all periods. The results in respect to the correlation coefficients between the strategies’ return and the S&P500 return exhibit that the majority of the strategies show a positive correlation greater than 0.5 to the market index, S&P500, across the four periods under study. The results of the test for difference of means in the correlation values during and after the crisis periods seem to suggest that the majority of the strategies and hedge fund universe composite indices increased their correlation with the S&P500 after the crisis. Those which have decreased the correlation with the market index are in the minority. Since the difference of means in the correlation is significant, it implies that the majority of the alternative investments may not provide diversification. When applying the CAPM and FF three factor model, the strategies that generated positive significant alphas are merger arbitrage (during the whole period) and merger arbitrage and convertible arbitrage (after the crisis period). As regards the HML factor, five strategies and four hedge fund universe composite indices have a significant negative exposure to the HML factor during the whole period. The significant negative contribution to HML implies that the portfolios of the said strategies were short in value stocks and long in growth stock. From a general perspective, the strategies and hedge fund universe composite indices do not have an exposure to the SMB factor of the FF model across all periods. During the whole period sample and the after-crisis period, for all strategies and hedge funds universe composite indices, the beta co-efficient of both the CAPM and FF model shows that it is rejected at the 1% significance level, except for macro/CTA and equity market neutral. These findings strongly suggest statistically that the majority of the managers of funds that follow such strategies fail to a large extent to hedge against the systematic market risk. During the crisis period, the beta co-efficient of both the CAPM and FF models shows that it is statistically significant at different levels except for macro/CTA and equity market neutral.