| Correlation of hedge fund returns at highest level in eight years |
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| 10/12/2006 | |
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The German central bank is sounding a note of alarm about the growth of hedge funds and the rising correlation in their returns. Using the un-weighted mean of the monthly returns of fund-of-hedge-funds over a twelve month-moving average, the Bundesbank reports that the correlation is at its highest level for eight years. In the aftermath of the LTCM blow up, hedge fund (and fund-of-hedge-fund) returns experienced four years of de-correlation, but ever since 2001, their returns have been more closely matched. The central bank used its internal calculations and the TASS database for its findings. A German central bank official told bfinance: "On the one hand, we have relatively resilient financial institutions like the investment and commercial banks with high profitability and good risk management, and on the other, we have an opaque hedge fund sector which has grown over the last quarters, and so, if we have a sudden change in sentiment, hedge funds will have an enormous market impact." Going up (and down), together Specifically, the correlation of fund-of-hedge-fund returns has increased from 0.4% in 1998 to 0.7% at present. In its newly released Financial Stability Review, the Bundesbank highlights a decline in correlation with event-driven investment strategies. It also cites a steady increase in long/short strategies, the most important as measured by trading volume. The heightened correlation between the returns of fund-of hedge-funds and the developments in the S&P 500 in May of 2006 demonstrates a pattern of co-movement in a setting characterised by a relatively sharp increase in volatility, notes the report. "Even in phases of slight disruptions, the correlation between hedge fund results is high." At the same time, the market impact of the industry has increased due to strong inflows into the sector in recent months, according to the Financial Stability Review. More than $25 billion flowed into hedge funds in the quarter ending September 2006, compared to only $12 billion for the same period in 2005. In the second quarter of 2006, the industry saw inflows of $39 billion compared to only $11 billion during the previous year. The Bundesbank official described the growing presence of hedge funds in a number of asset classes. In fixed income, hedge funds have a 15% market share of the total value of transactions. In less liquid markets, such as below-investment-grade bonds, they account for 25% of trading volume, in emerging markets (45%), in leveraged loans (32%) and in credit derivatives (58%). V.B. |
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