Hedge fund strategies posted contrasting returns in February. As table 1 shows, while directional and non-directional equity-oriented and event driven strategies benefited from a relatively favourable environment and achieved good performance in February, convertible arbitrage and CTA global suffered and fell short of their long-term average performance.
These contrasted results might be explained by the behaviour of the risk factors driving the performance of the different hedge fund strategies. The good performance of stock markets (1.89% for the S&P 500) and the widening of the size spread (the outperformance of the S&P 600 small cap index over the S&P 500 increased to 0.90% in February, close to its mid-term average), with another decrease in the credit spread (the credit risk, as measured by the difference in yields between two bonds rated Baa and Aaa, dropped to 0.60% in February) and an historically low level of implied volatility (12.08 for the VIX contract, the lowest level since November 1995), benefited long/-short equity, and, to a certain extent, event driven strategies (EDS) and equity market neutral (EMN).
In the same vein, EMN and EDS were able to take advantage of the flattening of the yield curve (the term spread decreased to 1.64%, its lowest level since August 2001), and the relatively low level of short-term interest rates. As a result of a favourable environment, long/short equity, EMD, and EDS succeeded in outperforming their long-term average performance in February.
Conversely, bearish bond markets, together with historically low levels of implied volatility, created a hostile environment for CTA global and convertible arbitrage. In spite of the increase in equity markets and the narrowing credit spread, convertible arbitrage posted a negative performance in February, leading to a disappointing -1.49% year-to-date performance. Unfavourable conditions seriously hampered CTA global’s upside potential, leading to a poor return despite the rally in the commodities markets (7.35% for the Goldman Sachs Commodity Index). CTA global performance was as a result flat.
Mathieu Vaissié, research engineer with the Edhec Risk and Asset Management Research Centre

Edhec methodology used
We used the Edhec Alternative Indices to measure the performance of hedge fund strategies and their exposure to major risk factors. These indices of indices have the merit of being by construction more representative and more stable than the hedge fund indices available on the market (see www.edhec-risk.com for more details). On the other hand, with hedge fund strategies showing significant extreme risks, we present three risk-adjusted performance indicators taking account of this specific feature. The adjusted Sharpe ratio, for example, involves replacing the volatility in the denominator of the traditional Sharpe ratio with the modified value-at-risk. The Sortino ratio divides the excess return of an asset over a pre-specified threshold (the minimum acceptable return is equal to 2.5% in our case), by the downside risk of this asset. Finally, the omega ratio involves dividing the probability weighted average return of an asset over a pre-specified threshold by the probability weighted average return of this asset below the same threshold.
For the sake of clarity, we only report correlation coefficients when factors appeared to be significant. These factors were identified as follows. In an attempt to highlight their true economic exposures to risk factors, we first corrected the hedge fund strategies’ historical return series for auto-correlation, following the iterative unsmoothing procedure introduced in Okunev and White (2004). We subsequently regressed hedge fund returns onto every single risk factor, and selected the ones showing co-efficients that were significant at a 95% confidence level. We finally calculated the correlation co-efficient of hedge fund strategies with the selected
factors.

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