Research

The consistently consistent: trade finance hedge funds maintain their winning edge amidst the trade war

Despite the escalation of the ongoing trade conflict between the US and China, trade finance hedge funds successfully traded their way around this challenge over the past few months. The Eurekahedge Trade Finance Hedge Fund Index has not spent a single month in the red since the year started, and has returned 3.51% as of July 2018 year-to-date, ahead of hedge fund managers utilising fixed income strategies as represented by the Eurekahedge Fixed Income Hedge Fund Index which gained 1.16% over the same period. The custom index, an equal weighted index composite of 26 unique trade finance hedge funds tracks US$3.7 billion in assets under management (AUM) as of July 2018, a figure which has surged more than 50% since the end of 2016.

Trade finance is the financing of a trade by an intermediary between a seller of goods and a buyer for the purpose of mitigating the risks for the two parties involved. The intermediary in this transaction, which typically is a financial institution, would ensure the security of the transaction by providing a letter of credit or bank guarantee on behalf of either the buyer or the seller. The trade finance hedge fund industry is estimated to manage US$13.5 billion in assets as of July 2018.

Figure 1 below compares the performance of the Eurekahedge Trade Finance Hedge Fund Index against fixed income hedge fund managers, as well as the global government and US high yield bond markets represented by the Merrill Lynch Global Government Bond Index II and the Merrill Lynch US High Yield Master II Index respectively.

Figure 1: Performance of trade finance hedge funds against comparable benchmarks since the end of 2009
Performance of trade finance hedge funds against comparable benchmarks since the end of 2009

As observed in Figure 1, trade finance hedge funds have managed to return 7.24% per annum, outperforming both their fixed income counterparts and the global government bond markets which returned 6.25% and 3.12% per annum respectively since the end of 2009. Even though the high yield bond markets generated a marginally superior annualised return, this asset class inherently carries higher risk and volatility compared to trade finance. It is pertinent to note that the Eurekahedge Trade Finance Hedge Fund Index has not posted a single month of loss since its inception in December 2009, exemplifying the lack of correlation between the performance of trade finance hedge funds and the financial markets in general.

Table 1: Performance in numbers – Eurekahedge Trade Finance Hedge Fund Index vs. comparable benchmarks

 
Eurekahedge Trade Finance Hedge Fund Index
Merrill Lynch Global Government Bond Index II
Merrill Lynch US High Yield Master II Index
Eurekahedge Fixed Income Hedge Fund Index
2010
9.76%
3.64%
15.19%
13.01%
2011
9.75%
6.09%
4.38%
4.32%
2012
8.17%
9.08%
15.58%
11.58%
2013
6.70%
(4.67%)
7.42%
5.75%
2014
6.39%
8.37%
2.50%
4.26%
2015
6.10%
1.22%
(4.64%)
0.88%
2016
6.03%
2.96%
17.49%
6.69%
2017
5.77%
1.16%
7.48%
6.54%
2018 year-to-date returns
3.51%
(0.35%)
1.19%
1.16%
2 year annualised returns
5.90%
(1.41%)
6.78%
5.23%
2 year annualised volatility
0.15%
2.31%
2.74%
1.40%
2 year Sharpe Ratio (RFR=2%)
26.42
(1.48)
1.74
2.31
3 year annualised returns
5.93%
1.46%
6.16%
4.37%
3 year annualised volatility
0.17%
2.77%
5.48%
2.17%
3 year Sharpe Ratio (RFR=2%)
23.61
(0.20)
0.76
1.09
5 year annualised returns
6.20%
2.70%
5.35%
4.54%
5 year annualised volatility
0.30%
2.87%
4.98%
2.01%
5 year Sharpe Ratio (RFR=2%)
14.16
0.24
0.67
1.27
5 year maximum drawdown
0.00%
(4.28%)
(23.00%)
(14.22%)

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 Trade Finance Hedge Fund Index returned 3.51% as of July 2018 year-to-date, outperforming its benchmarks despite the pressure of the US-China trade friction over the past few months. Trade finance fund managers have generated over three percentage points above the Eurekahedge Hedge Fund Index on a year-to-date basis.
  2. By virtue of the low volatilities associated with the trade finance strategies, hedge fund managers comprising the Eurekahedge Trade Finance Hedge Fund Index have generated exceptional Sharpe ratios over the past few years, vastly outperforming their benchmarks by this metric. Over the last five years, trade finance hedge fund managers generated a Sharpe ratio of 14.16.
  3. Apart from the exceptional risk-adjusted returns, trade finance hedge fund managers have also managed to provide incredible downside protection. The Eurekahedge Trade Finance Hedge Fund Index has not posted a single month of loss since its inception. On the other hand, fixed income hedge fund managers posted a maximum drawdown of -14.22% over the same period of time.

Table 2 provides the correlation values between the performances of trade finance hedge fund managers against their benchmarks. As seen in the Table 2, the Eurekahedge Trade Finance Hedge Fund Index is very weakly correlated to the three other indices. However, the p-value for the correlation coefficient between the returns of the trade finance hedge funds and those of the government bond index and the high yield bond index were 0.79 and 0.26 respectively, indicating a lack of statistical significance based on the sample space. On the other hand, the correlation coefficient between the Eurekahedge Trade Finance Hedge Fund Index returns and the Eurekahedge Fixed Income Hedge Fund Index returns were deemed to be of sufficient significance with a p-value of 0.06.

Table 2: Correlation matrix
Trade finance hedge funds correlation matrix

Source: Eurekahedge

Figure 2 provides the 12-months rolling alpha of the Eurekahedge Trade Finance Hedge Fund Index against both the Merrill Lynch Global Government Bond Index II, the Merrill Lynch US High Yield Master II Index, as well as the Eurekahedge Fixed Income Hedge Fund Index, assuming a risk-free rate of 0%. As seen in the figure, trade finance hedge fund managers were capable of generating positive alpha against the aforementioned benchmarks. Over the long-term period from the end of 2009 until July 2018, trade finance hedge funds yielded 0.58% alpha against both the government bond index and the high yield bond index.

Figure 2: 12-months rolling Alpha of trade finance hedge funds vs comparable benchmarks (RFR = 0%)
12-months rolling Alpha of trade finance hedge funds vs comparable benchmarks (RFR = 0%)

Figure 3 provides the performance distribution of all trade finance hedge funds in the Eurekahedge database, showing the highest, median, lowest returns, as well as the first and third quartiles on a yearly basis. Only three out of the eight years shown in the figure below have seen trade finance hedge funds losing money, most of which were moderately leveraged. Over the first seven months of 2018, trade finance hedge fund managers posted a median year-to-date return of 3.26%, and the spread between the first and third quartiles over this period was just below one percentage point.

Figure 3: Performance distribution of trade finance hedge funds
Performance distribution of trade finance hedge funds

Based on the data shown, 2013 saw the biggest spread between the best and the worst performing trade finance hedge funds, as global trade suffered due to capital outflows from emerging markets following the taper tantrum. The escalation of the global trade tension has seen the emerging market rout deepening over the past few months, as investors flee in favour of developed market assets, putting pressure on hedge fund managers focusing on trade finance. The constituents of the Eurekahedge Trade Finance Hedge Fund Index are also on track to post one of the lowest yearly median returns over the last eight years, signifying the trouble looming ahead of trade finance fund managers, should the trade friction between the US and China continue to worsen. On the brighter side, the spreads between the first and third quartiles as well as the best and worst year-to-date returns of these funds are at the lowest points since 2011, indicating that most trade finance hedge funds are still in good shape as of July. Given the strong track record of the Eurekahedge Trade Finance Hedge Fund Index, investors might remain confident that trade finance hedge funds would be able to weather the storm and end the year on a positive note.

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

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