Q3 2013 Hedge Fund Exposure & Tail Risk: Deconstructing Risk and Return Expectations and Stress Testing the 30 Largest Funds (eVestment)

November 2013

KEYWORDS: stress test, risk management, tail risk, Nasdaq, financial crisis, Volatility, Equity markets, currencies

Authors:

eVestment

Organizations:
  • eVestment

Summary:

1) When put through 11 major historical stress tests, the “Hedge Fund 30” portfolio has the largest risk of loss if markets undergo a scenario similar to the bursting of the 2000 technology bubble and ensuing NASDAQ crash. A recurrence of the financial crisis losses in September – October 2008 ranks fourth in terms of expected loss indicating the group, in aggregate, is relatively effectively positioned for such an event.

2) When shocking individual factors, along with the conditional response from the remaining factors, the basket is most at risk from its exposure to investment grade fixed rate asset backed securities. This is the only factor for which both portfolio losses and gains are greater than the amount the factor itself is stressed.  For example, a 5% drop in the ABS factor in the following month is expected to result in a -6.66% loss for the basket. Additionally, the portfolio expected to gain more with increases in the ABS focus than it is for declines; a 5% increase in the ABS exposure factor is expected to result in a 8.41% portfolio rise.

3) In addition to ABS, the group in aggregate appears bullish towards medium grade (BBB/BB) US corporate debt, global high grade (AAA) corporate debt and US equities, with a slant towards large cap and growth equities. The group appears bearish towards AAA-rated CMBS and high yield North American corporates.

4) The group appears to maintain a long-bias towards commodity markets, yet short-biased towards crude oil prices.

5) A decline in the USD relative to a basket of major currencies would benefit the group, as would a rise in equity market volatility, to a degree. Should equity market volatility spike significantly, the portfolio is expected to begin to show losses.

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