Case For ‘Overdiversification’ Remains Strong
August 2022
July was a good month for traditional asset classes with the S&P 500 up 9.2% and the Bloomberg Aggregate Bond index up 2.4%, but hedge fund indices had a mixed month on an absolute basis. The HFRX Equity Hedge, Relative Value Arbitrage, Convertible Arbitrage, and Merger Arbitrage indices each gained between 1.25% and 2.25% on the month, while the HFRX Macro/CTA and Systematic Diversified CTA indices closed lower by between 1.5% and 3.9% on the month as countertrend moves occurred across equity, fixed, currency, and commodity markets.
Rallies in traditional asset classes during July emboldened some prognosticators to signal the all-clear for investors as they expect the sell-off in stocks and bonds in mid-June to mark the lows for stocks and the highs in yields on long-term U.S. Treasuries for 2022. While we would like for that to be true, hope is not a strategy, and we are less certain of this desirable outcome materializing. After July’s bounce for stocks and bonds, valuations for both asset classes are less appealing, and a retest of mid-June levels could materialize as economic, geopolitical, and monetary policy uncertainties remain.
During July, exposures to equity hedge, convertible arbitrage, and merger arbitrage were additive to relative performance, and these are areas we believe hold appeal in the environment we envision. After a strong six-month run, managed futures detracted from both absolute and relative performance during July as trend following proved problematic with many markets making countertrend moves. However, if sized appropriately, managed futures can provide equity investors with ‘crisis alpha’ difficult to source elsewhere, particularly now as correlations between long-term Treasuries and stocks have risen and ‘safe haven’ bonds have more often than not failed to provide desired diversification benefits in 2022.
Our Diversified Strategies portfolio(s) should be expected to perform best on a relative basis versus traditional asset classes when volatility is elevated, bringing about drawdowns in stocks and/or bonds - in short, the opposite environment of what we witnessed in July as volatility remained subdued. However, the case for inclusion in multi-asset portfolios remains the same as Diversified Strategies continues to perform as expected, providing a consistent return and volatility profile capable of smoothing out an investor’s ride, allowing them to stay the course and avoid drastically altering their asset allocation framework which can have unintended and negative consequences over the long-term.
Source: Hedge Fund Research (HFR)
