Northern Trust Research Highlights Low Volatility, Positive Returns of Hedge Funds

Northern Trust’s Alternatives Group has published a research report indicating that the current market landscape looks ripe for hedge fund investment at a time when bond yields are falling in this low interest rate environment.

“When you get to rates this low, the risk/return for bonds looks very different than it did five or ten years ago,” said Tony Lissuzzo, director of hedge fund research for Northern Trust Alternatives Group.

Over the past year ending May 31, 2013, Barclays U.S. Aggregate Bond Index gained 0.93%, while the HFRI Fund of Funds Composite Index returned 8.42%.

“I think bond investors have been lulled into a sense of security,” said Lissuzzo. People tend to underestimate the risk with bonds, he said, while overestimating the risk with hedge funds.

Northern Trust’s research shows that hedge fund volatility has remained in line with that of bonds over the past year because hedge funds have a range of investment options rather than being tied to interest rates. For example, Northern Trust thinks event driven strategies should be successful, as mergers and acquisitions activity has picked recently.

Plus, hedge funds can change strategies if interest rates were to rise. Northern Trust’s research found that although the data is limited, hedge funds significantly outperformed bonds during the three extended periods interest rates went up over the last 20 years. During two of those periods—mostly in 1994 and in 1999—the Barclays index fell slightly, while the HFRI index rose 1.71% and 29.23% respectively.

While hedge funds have outperformed bonds, equities have fared even better over the last year, as the MSCI Index rose 26.71%. However, hedge funds experienced significantly less volatility than equities over this period, and Lissuzzo reasons that although hedge funds can not match this pace of returns that equities have provided, hedge funds are better positioned to survive market downturns.

When equities dropped 50% percent in 2008, Lissuzzo said, hedge funds hung in and only dropped 15% to 20%.

With many expecting a market pullback because the underlying economic fundamentals have not matched the rise in stock markets, “the risk/return for equities is not as favorable as it was before the rally,” said Lissuzzo. “For hedge funds, the opportunity set is as robust now as it was at the beginning of the year.”