When you invest with an equity hedge fund, you are actually getting two investments. One, a portfolio of equity risk premia, and two, the skill of the manager to blend these risk premia and find assets better than the returns from the premia. Hedge funds provide risk premia style exposure with their skill with the style. For example, a value manager is providing exposure to the value premium and his ability to find extra return. While we are not conducting a factor analysis of the different hedge funds, placing the returns from bank equity risk premia swap styles next the HFR hedge indices provides some insight on the return generation process.
The positive returns in risk premia this year are focused on four areas, low volatility and beta strategies, multi-style, size, and volatility. We will note that the volatilities for the HFR bank risk premia are in some cases more than double the volatility of the average hedge fund performance. A good portion of the low volatility risk premia came in May when equity markets declined. Equity hedge funds lost money last month, but generated gains in value and growth strategies for the year from the earlier strong movement in equities. There is a greater focus, as expected, on stock picking with hedge funds and not with strategies like low beta that are defensive in nature.
Equity risk premia can be bundled to provide successful alternatives to equity hedge funds, yet their focus on style exposures means there is still room for holding equity hedge funds with stock picking skills that may create more concentrated portfolios of specific opportunities.