Hedge funds looking to cut equity links

[HenryTo]

Hedge funds now have a 0.8 correlation to equities in general - and potentially looking to cut and bet on higher volatility going forward. Also is looking to get out of the carry trade in one piece because they don't think that will work anymore. As the saying goes, be careful what you wish for, because it may just come true:
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Hedge funds looking to cut equity links
Fri Jun 29, 2007 12:28 PM BST
By Jeremy Gaunt, European Investment Correspondent

LONDON (Reuters) - Credit Suisse's alternative investment arm is expecting hedge funds to try to lower the correlation between their returns and those of equity markets over the next six months as well to go long on volatility.

In an interview with Reuters on Thursday, Stephen Smith, managing director for alternative investments, said hedge funds would also be preparing for the "carry" trade to unwind and for an upswing in interest in distressed assets.

"Now people are saying that distressed investing is going to be the best (play) in town," Smith said.

His department manages some $60 billion (30 billion pounds) in hedge fund and quantitative business globally, including $20 billion in funds of hedge funds and passive investment via Credit Suisse's Tremont index.

Smith said many hedge funds had made money in the recent past by tracking equity markets as the global boom has continued.

With markets heading into a more volatile period the trick now would be to manage in a time of greater volatility.

"The correlation between a diversified portfolio of fund of hedge funds and the S&P (500 equity index) is about 0.8 percent, which is very, very high," he said.

"Investors are all looking for ways to be less exposed rather than more exposed to the equity market."

In a similar vein, Smith said that hedge funds were deeply involved in the "carry" trade and would be on the lookout for ways to exit as the backdrop that supports it changes.

The "carry" trade involves investors borrowing in low-yielding currencies such as the Japanese yen in order to invest in assets in high-yielding currencies.

In something of a warning, the yen has strengthened this week as investors have become nervous about global liquidity withdrawal. Smith said it was not clear when the "carry" trade would unwind, but that it was certain that it would.

"(Its) going to work until it stops horribly, brutally and sharply," he said. "It is difficult to see it unwinding elegantly."

With reference to hedge fund trends in general, Smith said that with risk premia so thin over the past few years, funds have been looking for opportunities outside major trading markets.

He said new areas inclused reinsurance, electricity and carbon credits.

[HenryTo]

A New York Fed study earlier this year suggesting that the high correlation coefficient between hedge funds and the broader market is merely a function of the low variance (standard deviation squared) of the stock market.

Article asserts that instead of looking at the correlation statistic, we should actually be looking at the covariance between hedge funds and the stock market:

http://www.newyorkfed.org/research/current_issues/ci13-3.html

[rffrydr]

Yeah?
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Today is the Tomorrow you worried about Yesterday!

[nodoodahs]

What they're missing, is that a basket of stock selection strategies can be uncorrelated to the broader stock market. Sad, really.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.