Strong year-end performance for hedge funds as measured by HFR indices was led by the fundamental growth and systematic CTAs categories. It is notable that the systematic CTA index performance from HFR was greater than what has been reported by other index providers. Generally, funds moved higher with the stronger equity beta. Given the decline in correlation across stocks, we have seen an increase in equity hedge fund alpha production.
Performance for the year was positive for all hedge fund strategies with the average return being 5.78% and the median equaling 5.99%. The high for the year was with the fundamental growth index which returned 20.13% while the low was with the market neutral index at 1.73%. The standard deviation for the index universe was 4.19%.
We were a little surprised that equity hedge funds were not able to generate better returns for the year from a combination of beta and alpha exposure. With equity indices generating 20% for large cap, there was plenty of upside return; however, many hedge funds engage in value and small cap trading which did not do as well as the more liquid large cap stocks.
Credit and fixed income was more in-line with beta alpha combinations. Systematic CTAs were able to generate good returns in the fourth quarter. Given the low to zero correlation with stock indices, the systematic mangers, who often focus on trends, were somewhat consistent with expectations.
2018 will be a testing year for hedge funds. On the one hand, higher dispersion across stocks will offer more alpha opportunities, but the high overvaluation with the likelihood of a market turn-around may prove difficult for managers to exploit. In the short-run cautious behavior may not be rewarded. For macro managers, the combination of central bank policy dispersion and economic growth impacting currencies and commodities may lead to more opportunities throughout the year.