Is hedge fund a hedge for equity markets?

Wei Kuang

Applied Economics, 2022, vol. 54, issue 27, 3154-3179

Abstract: The COVID-19 pandemic has severely impacted financial markets, triggering a flight from risky to safe-haven assets. This paper analyzes the safe-haven properties of hedge funds. Specifically, we examine the relative change in equity portfolio risk with a proportional allocation to hedge fund. Our analysis indicates that adding a composite hedge fund index to an equity portfolio results in a risk reduction relative to holding equities alone. The result is shown to hold across a range of allocation weightings and periods. The hedging effectiveness, however, varies across hedge funds strategies, downside risk measures, and allocation weightings. The arbitrage and event-type strategies are prone to tail risks and the undesired third and fourth moment of returns attributes reduce the effectiveness of tail risk reduction. This suggests that hedge funds can be used to provide shelter from turbulence in traditional markets, but appropriate strategies need to be selected to achieve effective hedging.

Date: 2022
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DOI: 10.1080/00036846.2021.2003748

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