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Indian hedge funds outperformed global peers amid COVID-19 pandemic

Indian hedge funds outperformed their global peers by a large margin in 2020, supported by the strong performance of the Indian equity market over the year. Despite the Indian economy’s 7.7% contraction in 2020 as a result of the devastating impact of the coronavirus pandemic, the Eurekahedge India Hedge Fund Index generated 19.88% return over 2020, dwarfing the 12.66% 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 2009. 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 2021, various concerns overshadow the future prospects of the Indian economy such as the possibility of a severe pandemic third wave which might necessitate the re-imposition of lockdowns, rising inflationary pressure, slow pace of vaccination, poor credit offtake in the commercial sector as well as the worsening fiscal position of the Indian government. The devastating second wave of COVID-19 had severely impacted lives, livelihoods and the economy in India, dampening consumer and business confidence due to the rising uncertainty of the trajectory of the pandemic.  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 strategy given the challenges with generating alpha amid the challenging economic environment in India.

Figure 1 below 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 growth equities in India as well as the MSCI India Value IMI Index which tracks value equities in India.

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 above 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 6.66% annualised return on average, falling behind the 10.02%, 9.55% and 7.56% returns per annum posted by the S&P BSE Sensex, MSCI India Growth IMI index and the MSCI India Value IMI index respectively. On the other hand, they managed to narrowly outperform the average annualised return of 6.39% 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)

MSCI India Value IMI (Local)

Eurekahedge Hedge Fund Index

2010

12.55%

17.43%

15.56%

13.88%

11.78%

2011

(23.73%)

(24.64%)

(23.63%)

(33.07%)

(1.67%)

2012

13.11%

25.70%

30.47%

27.62%

7.51%

2013

(8.52%)

8.98%

12.49%

(2.10%)

9.24%

2014

34.35%

29.66%

31.04%

25.38%

5.20%

2015

4.59%

(4.85%)

0.74%

(3.83%)

2.38%

2016

3.99%

1.95%

(2.25%)

2.46%

4.98%

2017

26.44%

27.91%

32.69%

34.21%

8.67%

2018

(7.36%)

5.91%

(4.23%)

(4.37%)

(3.55%)

2019

1.25%

14.38%

6.80%

5.73%

9.20%

2020

19.88%

15.75%

11.83%

23.21%

12.66%

May 2021 year-to-date

13.08%

8.77%

11.71%

16.79%

7.77%

2 year annualised return

16.12%

14.36%

12.60%

18.80%

12.76%

2 year annualised volatility

13.32%

25.36%

24.67%

27.07%

7.70%

2 year Sharpe ratio (RFR = 2%)

1.06

0.49

0.43

0.62

1.40

3 year annualised return

9.75%

13.71%

9.02%

15.37%

8.25%

3 year annualised volatility

13.08%

22.08%

22.33%

23.40%

6.95%

3 year Sharpe ratio (RFR = 2%)

0.59

0.53

0.31

0.57

0.90

5 year annualised return

10.89%

14.26%

11.19%

14.37%

7.61%

5 year annualised volatility

11.27%

18.49%

18.79%

19.83%

5.56%

5 year Sharpe ratio (RFR = 2%)

0.79

0.66

0.49

0.62

1.01

5 year maximum drawdown

(17.16%)

(28.57%)

(29.45%)

(32.18%)

(8.21%)

Source: Eurekahedge

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

  1. The Eurekahedge India Hedge Fund Index posted a return of 19.88% in 2020, outperforming the S&P BSE SENSEX and MSCI India Growth IMI index which returned 15.75% and 11.83% respectively. However, Indian hedge funds lagged behind the MSCI India Value IMI index which returned 23.21% in 2020. Looking at May 2021 year to date returns, Indian hedge fund managers posted a gain of 13.08%, outperforming all of the other indices listed in Table 1 except the MSCI India Value IMI index which returned 16.79%.

  2. Looking over the last two years, Indian hedge funds generated a Sharpe ratio of 1.06, which is noticeably better than the 0.49, 0.43 and 0.62 Sharpe ratios generated by the S&P BSE Sensex, MSCI India Growth IMI index and MSCI India Value IMI index respectively. Indian hedge funds managed to generate a significantly lower 2-year annualised volatility of 13.32% despite generating a 2 year annualised return of 16.12%, which is comparable to the 3 other Indian indices.

  3. Looking over the last three years, Indian hedge funds generated a Sharpe ratio of 0.59 which is marginally better than the 0.53 and 0.57 Sharpe ratios generated by the S&P BSE Sensex and  the MSCI India Value IMI index respectively and significantly better than the 0.31 Sharpe ratio generated by the MSCI India Growth IMI index. The significantly lower 3 year annualised volatility of 13.08% enabled Indian hedge fund managers to generate superior Sharpe ratios compared to the 3 other Indian indices.

  4. Looking over the last five years, Indian hedge funds generated a Sharpe ratio of 0.79, which is superior to the 0.66, 0.62 and 0.49 Sharpe ratios generated by the S&P BSE Sensex, MSCI India Value IMI index and the MSCI India Growth IMI index respectively. However, Indian hedge funds lagged behind global hedge funds which generated a Sharpe ratio of 1.01 as global hedge funds managed to generate a significantly lower 5 year annualised volatility of 5.56%.

  5. Indian hedge funds have posted a 5 year maximum drawdown of -17.16%, which is significantly lower than the -28.57%, -29.45% and -32.18% posted by the S&P BSE Sensex, MSCI India Growth IMI index and MSCI India Value IMI index respectively. This shows that Indian hedge funds have done very well in providing downside protection for their investors over the last 5 years. Having said that, global hedge funds have managed to post a significantly lower 5 year maximum drawdown of -8.21% over the same period as the more geographically diversified mandate allows global hedge fund managers to diversify their portfolios more widely and provide better downside protection for their investors.

Table 2a provides the correlation values between the performance of Indian hedge fund managers and the underlying equity market indices over the period from 2010 to May 2021 YTD.

Table 2a: Correlation matrix - 2010 to May 2021 YTD
Eurekahedge Indian Hedge Fund Correlation Matrix

Source: Eurekahedge

From the table above, we can see that the Eurekahedge India Hedge Fund Index return is strongly correlated to the performance of the S&P BSE Sensex as well as the MSCI India Growth IMI index and MSCI India Value IMI index. This suggests that a significant portion of the returns generated over the period were driven purely by the performance of the equity market itself. The Eurekahedge India Hedge Fund Index posted correlation coefficients of 0.85 to the S&P BSE SENSEX, 0.83 to the MSCI India Growth IMI index and 0.87 to the MSCI India Value IMI index in local currencies.

Table 2b provides the correlation values between the performance of Indian hedge fund managers and the underlying equity market indices over the period from June 2020 to May 2021.

Table 2b: Correlation matrix - 1 year
Eurekahedge Indian Hedge Fund Correlation Matrix

From the table above, we can see that the Eurekahedge India Hedge Fund Index is still strongly correlated to the performance of the S&P BSE Sensex as well as the MSCI India Growth IMI index and the MSCI India Value IMI index. However, the correlation coefficients are marginally lower compared to the figures seen in Table 2a. The Eurekahedge India Hedge Fund Index posted correlation coefficients of 0.77 to the S&P BSE SENSEX, 0.76 to the MSCI India Growth IMI index and 0.76 to the MSCI India Value IMI index. This suggests that Indian hedge fund managers could have implemented strategies to diversify a portion of their portfolio exposure away from the Indian equity market amid the coronavirus pandemic.

Figure 2 below provides the 12-months rolling alpha of the Eurekahedge India Hedge Fund Index versus the S&P BSE SENSEX Index and the Eurekahedge Asia ex Japan Hedge Fund Index, assuming a risk-free rate of 0%. As of May 2021, the rolling alpha generated by Indian hedge fund managers stood at 1.02% against the S&P BSE SENSEX Index and 0.60% against the Eurekahedge Asia ex Japan Hedge Fund Index. Looking over 2020, the alpha generated by Indian hedge fund managers stood at 0.82% against the S&P BSE SENSEX index and 0.24% against the Eurekahedge Asia ex Japan Hedge Fund Index.

Figure 2: 12-months rolling Alpha of Indian hedge funds vs underlying equity market and Asia ex Japan hedge funds (RFR = 0%)
12-months rolling Alpha of Indian hedge funds vs underlying equity market and Asia ex Japan hedge funds

Source: Eurekahedge

These alpha figures are rather discouraging considering that the Indian 10-year government bond yield stood at 6.02% by the end of May 2021. 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 and the average Asia ex Japan hedge fund after accounting for inflation.

Figure 3 below provides the performance distribution of Indian hedge funds in the Eurekahedge database, showing the median return, 10th and 90th percentile returns, as well as the top and bottom quartile returns on a yearly basis since 2010. Since 2011, the return dispersion among Indian hedge funds has remained consistently above the levels seen in 2010 when the top/bottom dispersion was 13.15%. In 2014, Indian hedge funds recorded their largest top/bottom dispersion of 64.01% as the top 10% of Indian hedge funds returned 77.46% while the bottom 10% returned 13.45%, supported by the strong performance of the S&P BSE SENSEX index which returned 29.66% in 2014. In the same vein, the top/bottom dispersion of Indian hedge funds in 2017 was 51.08% when the S&P BSE SENSEX returned 27.91% over the year. 2018 and 2019 saw the Indian hedge fund industry underperform the Indian equity market significantly. The S&P BSE SENSEX index returned 5.91% in 2018 while the median Indian hedge fund lost 8.43%. The underperformance of Indian hedge funds worsened in 2019 as the S&P BSE SENSEX index managed to generate a return of 14.38%, outperforming even the top 10% of Indian hedge funds which returned 13.91%. Going into 2020, the top/bottom dispersion of Indian hedge funds widened significantly to 51.18% as the onset of the coronavirus pandemic led to heightened volatility in global equity markets. In 2021, top/bottom dispersion was significantly lower at 35.83% despite the second wave of COVID-19 fueled by the Delta variant hitting India harder than the first wave in 2020. In spite of the severe hit to the Indian economy as a result of the coronavirus pandemic, the median Indian hedge fund returned 14.28% in 2020 and 10.36% over the first 5 months of 2021, outperforming the average global hedge fund which returned 12.66% in 2020 and 7.77% over the first 5 months of 2021. As the threat of a third COVID wave in India looms large, it is important for Indian hedge funds to take a more cautious approach to protect against downside risk especially since the Indian equity market is currently trading at more than 30x earnings which is not cheap when compared to the historical average.

Figure 3: Performance distribution of Indian hedge funds since 2010
Performance distribution of Indian hedge funds since 2010

Source: Eurekahedge

Table 3 below provides the detailed performance comparison and statistics of Indian hedge funds vs their regional and global hedge fund peers as represented by the Eurekahedge Greater China Hedge Fund Index, Eurekahedge Asia ex Japan Hedge Fund Index and the Eurekahedge Hedge Fund Index.

 

Eurekahedge India Hedge Fund Index

Eurekahedge Greater China Hedge Fund Index

Eurekahedge Asia ex Japan Hedge Fund Index

Eurekahedge Hedge Fund Index

May 2021 year-to-date return

13.08%

5.45%

6.83%

7.77%

2020 return

19.88%

35.57%

23.12%

12.66%

2 year annualised return

16.12%

25.42%

18.50%

12.76%

2 year annualised volatility

13.32%

11.35%

10.07%

7.70%

2 year Sharpe ratio (RFR = 2%)

1.06

2.06

1.64

1.40

3 year annualised return

9.75%

12.34%

9.77%

8.25%

3 year annualised volatility

13.08%

12.26%

9.81%

6.95%

3 year Sharpe ratio (RFR = 2%)

0.59

0.84

0.79

0.90

5 year annualised return

10.89%

14.06%

10.70%

7.61%

5 year annualised volatility

11.27%

10.36%

8.07%

5.56%

5 year Sharpe ratio (RFR = 2%)

0.79

1.16

1.08

1.01

5 year maximum drawdown

(17.16%)

(16.55%)

(11.67%)

(8.21%)

Key takeaways include:

  1. The Eurekahedge India Hedge Fund Index has outperformed the three other indices in the first five months of 2021, posting a return of 13.08%, which is significantly higher than the returns posted by their Greater China, Asia ex-Japan and global counterparts as they posted returns of 5.45%, 6.83% and 7.77% respectively. Looking at 2020 returns, Indian hedge funds returned 19.88%, outperforming their global hedge fund peers who returned 12.66% but lagged behind their Greater China and Asia ex Japan counterparts who returned 35.57% and 23.12% in 2020 respectively.

  2. Comparing the Sharpe ratios across 2 year periods, 3 year periods and 5 year periods, Indian hedge funds have consistently generated Sharpe ratios that are the lowest among the four indices listed in Table 3. The Sharpe Ratios of Indian hedge funds are lower compared to their peers because of their persistently higher annualised volatility as a result of large exposure to the highly volatile Indian equity market.

  3. Indian hedge funds have posted the largest 5 year maximum drawdown among their hedge fund peers of -17.16%. In comparison, Greater China, Asia ex Japan and Global hedge funds posted 5 year maximum drawdowns of -16.55%, -11.67% and -8.21% respectively. The more geographically diversified nature of their regional and global hedge fund peers allows hedge fund managers to better limit their downside risk as compared to the more concentrated nature of the Indian mandate.

In conclusion, even though the numbers indicate that average Indian hedge funds may not be able to generate enough alpha to justify their fees, Indian hedge funds have managed to improve their risk-adjusted returns in the recent years, as seen in their 2 year Shape ratio of 1.06 which is more than double of the 2 year Sharpe ratio recorded by the S&P BSE SENSEX index. 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 the near future may pose headwinds for the country’s young and growing hedge fund industry. To address these challenges and attract investments in India, the Indian government has implemented measures such as the raising of FDI limits across key sectors, launching of the Production-Linked Incentive Scheme and expansion of the National Infrastructure Pipeline project. The Reserve Bank of India have also since November 2020 taken conventional and unconventional liquidity infusion measures to facilitate overall credit growth in the Indian economy. Having said that, the Indian government will also have to take steps to ensure that an effective COVID-19 vaccination roll-out strategy is in place and provide skills training to upskill their labour force to enable a strong rebound from the COVID-19 pandemic as well as sustainable and broad-based economic growth in the long-run. With an improved economic environment and supportive government policies in place, the Indian hedge fund industry has the potential to generate better performance and attract more investor capital and eventually catch up with their developed country counterparts.

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