By Simon Kerr, Publisher of Hedge Fund Insight
Equity long/short managers have done okay in 2012. With the S&P500 up 15.0% in 2012 US based equity long/short managers were up 7.0% to the end of November according to the Greenwich Hedge Fund Index. Given the risk on/risk off market environment through 2012 that is a reasonable outcome at the index level, though some stock picking managers, like Viking and Tosca, have done a lot better.
There are reasons to think that 2013 will be a lot more benign for hedge funds that invest in equity based strategies. For one, any stability in markets will bring about a lot more M&A, activity which has been muted since the market lows of 2009. A second reason is that a more consistently positive market environment will allow net exposures of equity hedge funds to drift up – the 7% increase in net exposure over November will be a the start of a trend.
Pairwise Correlations Between S&P500 Constituents
Source: BofA Merrill Lynch Quant Research
The third reason is illustrated in the chart above. Most hedge fund managers major on their stock selection ability rather than their ability to manage the net to the benefit of investors. It is clear from the data provided by BofA Merrill Lynch that the constraint on returns of high intra-market correlation has lessened significantly. The average correlation between pairs of the S&P 500 constituents is now around 0.3, down from the 0.7 level seen last year. In short 2013 is expected to be the best market environment for stock selecting equity hedge funds for a number of years.