Market neutral funds found to be (relatively) immune when liquidity dries up
| Sep 21st, 2009 | Filed under: Academic Research, Performance, Analytics & Metrics, Today's Post | By: Alpha Male |
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Although hedge funds in general have displayed an uncomfortably high equity beta over the past year, there have been two bright spots – strategies that follow-through on the promise of low market correlation (and therefore, assuming returns are positive, alpha). Global Macro is one such category. Market Neutral is the other.
When you think about it, this is somewhat counter-intuitive. Market neutral funds tend to use more quantitative strategies and trade more often than their buy (/sell) and hold long/short cousins. So you’d think that they rely heavily in market liquidity to get in and out of so many positions so quickly.
You might also think that market neutral funds would rely on funding liquidity to employ leverage. When funding liquidity dries up, one might expect that market neutral funds would therefore suffer.
But it turns out that both of these assumptions may in fact be wrong. A paper by Arjen Siegmann and Denitsa Stefanova of VU University Amsterdam seems to suggest that the more market neutral a fund, the less it is affected by liquidity shocks (market liquidity and funding liquidity).
Rather than relying on managers’ self-identify as “market neutral”, Siegmann and Deitsa divide the universe of equity hedge funds into 5 buckets based on their equity betas. Then they regressed the monthly beta of the funds in these buckets against the TED spread (used as a proxy for funding liquidity) and against a measure of market liquidity called the “ILLIQ” measure (average daily price move over average daily volume).
It turned out that the higher the equity beta of the fund, the stronger the relationship of that funds’ beta to both of these liquidity measures. Or put another way, the beta of market neutral funds actually seemed to be less dependent on market and funding liquidity – not more dependant (see charts below constructed with data from the paper). More…
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