3 Nov 2010
GFIA has released findings on how the correlation between different hedge fund strategies and their benchmark indices within a seemingly diversified portfolio changed during the credit crisis.
In this paper, GFIA observes how correlations increased dramatically after October 2007, demonstrating how the measured correlations for the period 2001 to 2010 would have been misleading if used as a predictor of portfolio diversification. GFIA’s study confirmed that, in the credit crisis, there was a strong tendency for almost all hedge fund cross- and index-correlations to converge on one.
Summary findings include:
- The generally low correlations between Asian hedge fund strategies 2001-2007 exploded in the crisis, with average increase in correlation of 0.31, making most strategies effectively correlated.
- Many strategies also suddenly became highly correlated to their underlying indices.
In this paper, GFIA observes how correlations increased dramatically after October 2007, demonstrating how the measured correlations for the period 2001 to 2010 would have been misleading if used as a predictor of portfolio diversification. GFIA’s study confirmed that, in the credit crisis, there was a strong tendency for almost all hedge fund cross- and index-correlations to converge on one.
Summary findings include:
- The generally low correlations between Asian hedge fund strategies 2001-2007 exploded in the crisis, with average increase in correlation of 0.31, making most strategies effectively correlated.
- Many strategies also suddenly became highly correlated to their underlying indices.
Peter Douglas CAIA, principal of GFIA, commented: “Whereas the Asian hedge fund universe had always been helpfully uncorrelated, facilitating effective portfolio construction, post crisis correlations increased dramatically, underlining the danger of relying on historical correlations as a portfolio construction tool”.
