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Eurekahedge 50 Index: The Year in Review and a Look Forward to 2016

The Eurekahedge 50 (EH50) index was designed to represent the exposures and experience of institutional hedge fund investors. Seeking to create a more selective benchmark reflective of diversified, institutional-quality multi-manager portfolios, Markov Processes International (MPI), in partnership with Eurekahedge, launched this unique Index in December 2014. After its first full year, the industry’s first measure of the collective performance of top hedge funds delivered better risk-adjusted returns with fewer turnovers than all-inclusive hedge fund indices.

2015 Performance Highlights
Annualised Return (%)
Annualised Standard Deviation (%)
Max Drawdown Period
Max Drawdown Return (%)
Eurekahedge 50 Index
0.01
3.03
Jun-15 - Sep-15
(3.49)
HFRI FW Composite Index
(1.02)
4.45
Jun-15 - Sep-15
(5.40)
DJ Credit Suisse Hedge Fund Index
(0.71)
3.65
Jun-15 - Dec-15
(3.93)
Barclay Hedge Fund Index
0.04
5.02
Jun-15 - Sep-15
(5.83)

Source: Bloomberg, Quantvest

Index methodology passed several tests in a turbulent year

Hedge fund managers struggled greatly in 2015. The total number of hedge funds liquidated in 2015 was up to 744, with more closings expected as the full impact of year-end redemption notices from investors’ filters in. Fund closures distort measures of hedge fund performance, particularly for all-inclusive hedge fund indices. Survivorship bias occurs when funds cease reporting to a database, which creates an upward bias for the given hedge fund index, leading to inaccurate representation of performance1.

EH50 Difference

In contrast, using objective quantitative criteria, 50 of the largest, most in-demand hedge funds with proven track records and attractive risk-adjusted returns over a number of market cycles are selected for inclusion in the Eurekahedge 50 index. We believe that such an approach is more reflective of the fund selection process of institutional investors and funds of funds. The EH50 institutional-quality fund inclusion criteria coupled with ongoing monitoring and quantitative due diligence resulted in low fund turnover and little survivorship bias in 2015.

EH50 withstands market volatility

2015 was a year associated with unusual market volatility. On August 24, the Chicago Board Options Exchange’s Volatility Index, the VIX, briefly jumped to a level not seen since the depths of the financial crisis. Amidst this turmoil, the EH50 was down only -1.02% in August, better than all broad hedge fund benchmarks in the market2. The primary reason for this outperformance can be attributed to the risk controls that these 50 funds demonstrated. As Table 1 shows, the median August return for EH50 constituents was -0.35%, and 75% of all funds’ returns were within a narrow range, between -1.56% and 2.31%. In contrast, hedge fund returns in the Eurekahedge database exhibited extreme dispersion, between -76.42% and 107.49%. EH50’s outperformance and relatively narrow dispersion in August highlighted the robustness of EH50 fund selection methodology.

Table 1: Quartile performance of hedge fund index constituents – August 2015

August Return (%)
EH50 Constituents
Eurekahedge Hedge Fund Universe
Minimum
(8.43)
-76.42
1st quartile
(1.56)
-4.63
Median
(0.35)
-1.63
3rd quartile
0.18
0.08
Maximum
2.31
107.49

Source: Bloomberg, Quantvest

EH50 performance aligns with institutional expectations for hedge fund portfolios

In contrast to conventional wisdom, institutional investors do not expect hedge funds to outperform the S&P 500. Instead, the expectation from fund managers is to provide long term capital appreciation through the pursuit of an absolute returns strategy that focuses on mitigating downside risk.

Table 2 summarises the performance of the EH50 and other hedge fund benchmarks for the past three years3.

Since 2013, the EH50 has consistently produced more attractive risk-adjusted returns than those of broad hedge fund indices. Additionally, the Index experienced the smallest maximum drawdown, coupled with a lower correlation to the S&P 500.

Table 2: Performance statistics for the past 36 months

January 2013 – December 2015
Annualised Return (%)
Annualised Standard Deviation (%)
Sharpe Ratio
Max Drawdown Period
Max Drawdown
Correlation with S&P 500
Eurekahedge 50 Index
4.80
3.03
1.55
Jun 2015 – Sep 2015
(3.49)
0.73
EH50 tracker Index
6.89
3.39
1.97
Jun-2015 – Sep 2015
(2.82)
0.83
HFRI FW Composite index
3.62
3.89
0.92
Jun 2015 – Sep 2015
(5.40)
0.86
DJ CS Hedge Fund Index
4.30
3.51
1.20
Jun 2015 – Sep 2015
(3.93)
0.72
Barclay Hedge Fund Index
4.66
4.20
1.09
Jun 2015 – Sep 2015
(5.71)
0.87
HFRX Global Hedge Fund Index
0.74
3.73
0.20
Sep 2014 – Dec 2015
(6.04)
0.84

Source: Bloomberg, Quantvest

Note: EH50 Tracker Index is gross of management fee and other costs

Less is more: on avoiding small fund bias

An all-inclusive hedge fund index, with thousands of constituents, is inherently biased towards small funds. As a result, performance of such indices likely reflects the volatility associated with small funds (as shown in Table 2). The EH50 methodology, however, favours large funds with a significant institutional investor base. This methodology helped the Index achieve better risk diversification than a broad index of 1,000+ hedge funds (such as HFRI Composite).

EH50 Tracker Index

An important expectation and characteristic of a hedge fund index is that it be investable. Timely pricing of hedge funds is difficult and unreliable due to infrequent performance reporting and other concerns. Because of this, hedge fund indices most likely do not represent investors’ actual returns. An investable index patterned on the EH50 was created to address this. The EH50 Tracker Index uses a proprietary quantitative methodology and is comprised of tradable and liquid instruments. As Figure 1 shows, the Tracker Index did indeed closely follow EH50, generating a three-year tracking error4 of 1.89%, a very low figure relative to other hedge fund replication indexes.

Figure 1: EH50 Index (white) vs. EH50 Tracker (red) since 2013. (Bloomberg : EHFI400 and EHFI401)
 

A peek into 2016: EH50 reconstitution and rebalance

Following our quantitative, rule-based index construction and management methodology, EH50 was reconstituted and rebalanced at the end of 2015. The overall characteristics of the 50 constituent funds selected for 2016 are similar to those comprising the Index in 2015. On average, the 50 funds have a history of more than 13 years and average minimum investment of over US$3.4 million. All EH50 constituents have maintained superior risk-adjusted returns, with emphasis on stability and consistency. Figures 2 and 3 demonstrate the breakdowns in investment strategies by total AUM and number of funds, respectively.

Figure 2: Fund AUM breakdown by investment strategies, 2016 EH50 reconstitution (US$ billion)
 

Seventy percent of the funds selected for inclusion in the EH50 at the beginning of 2015 retained membership for 2016. The funds that didn’t pass annual quantitative screens saw significant decreases in AUM and/or poor risk-adjusted performance, including several credit-oriented relative value funds.

Figure 3: Fund breakdown by investment strategies, 2016 EH50 reconstitution
 

Concluding remarks

The Eurekahedge 50 index was created to more accurately reflect the composition and returns of institutional investors’ hedge fund portfolios. In the first full calendar year after its launch, the EH50 recorded better risk-adjusted returns than popular all-inclusive measures of the hedge fund universe, while minimizing the biases inherent in such benchmarks. In accord with its design, EH50 has proved to be a robust index that meets the demand of hedge fund investors seeking a more representative benchmark of their actual investments.

 

This article originally appeared in Quantvest’s Issue III newsletter dated January 2016. For more information please visit www.quantvest.com.

This document is provided for information purposes only. It does not constitute any offer or solicitation with respect to the purchase or sale of any security. Any offering or solicitation will be made only to qualified prospective investors pursuant to final offering documents, all of which should be read in their entirety.

Although information contained herein is obtained from sourced believed to be reliable, Quantvest Capital LLC (the “Company”) makes no representation, express or implied, as to the accuracy, fairness, sufficiency or completeness of such information, opinions or beliefs contained in this document.

This document includes hypothetical performance results based on data and other information provided by third parties, and is subject to the assumptions and methodology described herein.

Hypothetical performance results are not necessarily indicative of future results, and have many inherent limitations, some of which are described herein. No representation is being made that results similar to those shown can be achieved in the future. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular business or investment strategy.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical investing does not involve financial risk, and no hypothetical investing record can completely account for the impact of financial risk on actual investing, although the Company attempts to mitigate this effect by avoiding emotion-driven investment decisions with its systematic investment process. There are numerous other factors related to the proposed investment activities which cannot be fully accounted for in the preparation of hypothetical performance results. Timing of transactions, and general economic and market conditions prevailing at the time of investment may cause actual results to differ materially from the simulated results shown herein. Hypothetical performance results included herein are for informational purposes only and do not constitute investment advice or recommendations. Any responsibility for the selection or purchase of any investment based on hypothetical performance results included herein is taken and assumed solely by the recipient of this document.


Footnote
1 A study Ross Barry in 2003 “Hedge Funds: A Walk Through the Graveyard” estimates a performance deviation of 3.7% annually as a result of “survivorship bias”.
2 In August, HFRI Composite Index, Barclay Hedge Fund Index, Credit Suisse Hedge Fund Index, and Deutsche Bank Hedge Fund Index fell -2.37%, -2.50%, -1.96%, and -1.87% respectively.
3 Prior to Jan. 2015, performance of EH50 and the EH50 Tracker Index were simulated. EH50 Tracker Index is an investable index that tracks the performance of EH50 Index, using proprietary quantitative methodology.
4 Prior to Jan 2015, performance of EH50 and the EH50 Tracker Index were simulated. EH50 Tracker Index performance is gross of fees and other expenses.
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