Ever noticed that the term “decoupling” is almost always used to describe a situation where one asset tanks and the other manages to hold up okay? A couple of years ago, many assumed that Asian economies had decoupled from the US economy – in other words, that a downdraft or stagnation in the US economy would not be commensurately felt in Asia.
But no one seems to have commonly referred to the dot-com bubble as a “decoupling” of Internet stocks from the bricks-and-mortar economy and few described last summer’s oil or potash bubble as a “decoupling” from other assets.
So far in 2009, hedge funds seem to be holding up (i.e. flat) while equity markets fall off their bar stools. In a new report, Credit Suisse describes this year’s performance as “continuing January’s decoupling trend from equity markets.”
In fact, this year’s performance has been so “decoupled” from equity markets that return differences in January and February (2 months) are enough to push the 36-month rolling correlation of hedge funds down about 10%.
Although some studies have suggested hedge funds do have statistically-significant market timing ability, the frequent sharp drops in this chart could just as easily be a result of hedge fund returns remaining flat while markets fell – in other words, of truncated downsides, or as some has described it, “asymmetric returns“.
A high equity beta isn’t a bad thing assuming the manager knows when to jump off the beta bandwagon. The dramatic spike in correlation during last 2008 may be remembered by history as a time when the hedge fund industry got caught with its hand in the beta cookie jar. But apparently, it has quickly removed that hand and has sworn off cookies (for now at least).
The bottom line is that both out-performance and low-correlation are often the by-product of downside protection (“decoupling”) rather than absolute returns.
This phenomenon may be at work within the hedge fund industry as well. As Credit Suisse points out, Global Macro hedge funds outperformed the broader hedge fund index in times of high market volatility (measured by the VIX).
Before you try to guess why Global Macro funds do well in high volatility environments, note that the dark blue line in the chart above shows relative performance vs. the broader hedge fund industry, not absolute performance. In other words, it shows a “decoupling” from other hedge fund strategies. When hedge funds took it on the chin in late 2008 along with equities, Global Macro didn’t actually thrive, it simply held the line. The chart below from Hedge Fund Research shows the divergent fortunes of Macro funds and hedge funds in general:
You can see how the 1998 performance spike in the CS chart was actually just a lesser drawn down than that experienced by the broader the hedge fund industry that year. This relative performance advantage evaporated by 2000 as confirmed above and also by the relative measure in the CS chart.
Fast forward to 2008 and you can see from the HFR chart that the Global Macro out-performance identified by CS wasn’t a sign of great returns, but of downside protection – of the decoupling of global macro from hedge funds in general.
In this sense, the decoupling of global macro from the hedge fund industry is arguably even more dramatic than the decoupling of hedge funds from equities.