Research

Indian Hedge Funds: Good Returns, Mediocre Alpha?

Indian hedge funds outperformed their global peers by a large margin in 2017, riding on the back of the Indian equity market’s exceptional performance over the year. The Eurekahedge India Hedge Fund Index generated 28.96% return over 2017, dwarfing the 8.25% return posted by the Eurekahedge Hedge Fund Index over the same period, which also happened to be the best annual performance of the global hedge fund industry since 2013. However, most of those gains were generated through exposure toward the fast growing equity market of the country, raising the question of whether some of these hedge fund managers actually generate enough alpha for their investors to justify their management and performance fees.

Going into 2018, various concerns overshadow the future prospects of the Indian economy such as slowing economic growth, stunted pace of financial reforms, capital outflow risks and most importantly the twin deficits which the government is currently nursing. This may be a good time to revisit the performance of Indian hedge funds in order to determine whether dedicated exposure to this mandate should give way to a more diversified pan-Asian exposure given the challenges with generating alpha in this single country mandate.

Figure 1 illustrates the performance of the Indian hedge fund managers since the end of 2009 compared to their global peers, as well as the underlying equity market of the region as represented by the S&P BSE SENSEX index. The chart also includes the MSCI India Growth IMI Index which tracks the growth equities in India, the primary driving force behind the incredible performance of the Indian equity market in 2017.

Figure 1: Indian hedge fund managers trail behind the underlying equity market since end of 2009
Indian hedge fund managers trail behind the underlying equity market since end of 2009

As the figure shows, Indian hedge fund managers actually failed to capture a major portion of the growth of the equity market over the period starting in the end of 2009, which is not completely unexpected as hedge funds are expected to hedge themselves against the market, in order to provide some downside protection for their investors. Since December 2009, Indian hedge funds generated 6.23% annualised return on average, falling behind the 8.48% and 9.43% returns per annum posted by the SENSEX index and the MSCI India Growth index respectively. On the other hand, they managed to narrowly outperform the average annualised return of 5.51% generated by the global hedge fund industry over the same period.

Table 1: Performance in numbers: Indian hedge funds vs underlying equity market and global hedge funds

 
Eurekahedge India Hedge Fund Index
S&P BSE SENSEX
MSCI India Growth IMI (Local)
Eurekahedge Hedge Fund Index
2010
13.23%
17.43%
15.56%
11.56%
2011
(24.73%)
(24.64%)
(23.63%)
(1.75%)
2012
13.47
25.70%
30.47%
7.35%
2013
(9.21%)
8.98%
12.49%
9.03%
2014
39.25%
29.89%
31.04%
5.10%
2015
4.33%
(9.56%)
0.74%
2.09%
2016
3.84%
11.20%
(2.25%)
4.60%
2017
28.96%
30.04%
32.69%
8.25%
March 2018 year-to-date
(3.62%)
(4.93%)
(5.18%)
(0.13%)
2 year annualised returns
5.91%
5.95%
5.39%
2.54%
2 year annualised volatility
7.88%
11.27%
10.81%
2.45%
2 year Sharpe Ratio (RFR=2%)
0.50
0.35
0.31
0.22
3 year annualised returns
5.02%
4.83%
2.62%
2.28%
3 year annualised volatility
9.88%
13.19%
12.72%
3.16%
3 year Sharpe Ratio (RFR=2%)
0.31
0.21
0.05
0.09
5 year annualised returns
11.96%
12.67
13.19%
5.09%
5 year annualised volatility
12.28%
13.28%
12.32%
2.98%
5 year Sharpe Ratio (RFR=2%)
0.81
0.88
0.91
1.04
5 year maximum drawdown
(20.16%)
(21.18%)
(18.94%)
(4.37%)

Source: Eurekahedge

Table 1 provides the detailed risk return statistics of the four indices shown in the figure above. Key takeaways include:

  1. The Eurekahedge India Hedge Fund Index posted a return of 28.96% in 2017, marginally losing against the SENSEX and MSCI indices which posted 30.04% and 32.69% respectively over the year. Looking at the first quarter of 2018, Indian hedge fund managers posted an average loss of 3.62%, which is slightly ahead of the performance posted by the two indices tracking the Indian equity market, indicating that these fund managers indeed provide some downside protection for their investors.
  2. Looking over the last two years, Indian hedge funds generated a Sharpe ratio of 0.50, which is noticeably better than the 0.35 and 0.31 Sharpe ratios generated by the SENSEX and MSCI indices respectively. A similar trend could be observed over the last three years, with Indian hedge funds generating better Sharpe ratio on average than the two equity indices.
  3. Over the last five years, the Eurekahedge India Hedge Fund Index posted a Sharpe ratio of 0.81, which is narrowly ahead of the performance generated by the overall Indian equity market (0.80 Sharpe ratio for the SENSEX index), but behind the performance of the growth equities in the region (0.91 Sharpe ratio for the MSCI growth index).
  4. Indian hedge fund managers also posted a maximum drawdown of -20.16% over the last five years, which is rather unimpressive considering the SENSEX index posted a maximum drawdown of -21.18% over the same period. For reference, the Eurekahedge Hedge Fund Index which represents the global hedge fund industry posted a maximum drawdown of -4.37% over the last five years.

Table 2 provides the correlation values between the performance of Indian hedge fund managers and the underlying equity market indices over the period starting in December 2009.

Table 2: Correlation matrix
Indian hedge fund managers and the underlying equity market indices correlation matrix

From the table above we can see that the Eurekahedge India Hedge Fund Index return is strongly correlated to the performance of the growth equities of the region, possibly signifying that a significant portion of the returns generated over the last few years were driven purely by the performance of the equity market itself. The Eurekahedge India Hedge Fund Index posted correlation coefficients of 0.66 to the S&P BSE SENSEX index and 0.81 to the MSCI India Growth IMI Index in local currencies.

Figure 2 provides the 12-months rolling alpha of the Eurekahedge India Hedge Fund Index versus the S&P BSE SENSEX Index and the MSCI India Growth IMI Index, assuming a risk free rate of 0%. As of March 2018, the rolling alpha generated by Indian hedge fund managers stood at 0.14% against the SENSEX index and 0.34% against the MSCI index. Looking over 2017, the alpha generated by Indian hedge fund managers stood at 0.38% against the SENSEX index and 0.37% against the MSCI index.

Figure 2: 12-months rolling alpha of Indian hedge funds vs underlying equity market (RFR = 0%)
12-months rolling alpha of Indian hedge funds vs underlying equity market

These alpha figures are rather discouraging considering that the Indian 10-year government bond yield stood at 7.40% by the end of March 2018. Using a risk free rate closer to the inflation rate of the region would push the two rolling alpha graphs in the figure above almost entirely in the negative territory, indicating that on average, Indian hedge fund managers failed to generate any positive alpha over the equity market performance after taking into account inflation.

Despite the numbers indicating that average Indian hedge funds may not be able to generate enough alpha to justify their fees, we must remember that the Indian hedge fund industry is still relatively young compared to those of North America and Europe, for instance. As the industry matures, a natural selection process would take place as investors learn more about the region’s economy and alternative investment space. Underperforming fund managers would be weeded out, while good performers would attract more investor capital over time, effectively improving the overall industry performance. Some of the hedge fund managers may also look to diversify their investment mandate into broader geographies as their AUM base grows bigger and grow out of the limitations of investing exclusively in a single country. However, as of now, this inability to generate excess returns combined with the various challenges the Indian economy is likely to face in near future may pose headwinds for the country’s young and growing hedge fund industry.

The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.

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