With a crazy week coming to a close with stocks now down only -1.6% or so after staring losses of -8.5% in the face early Tuesday morning – we carved out a few minutes to check in on how managed futures better known cousins, hedge funds, are doing in this mini crisis (still, no clever name for this one yet…)

We checked out Dow Jones Credit Suisse’s Hedge Fund Index stats to get a peek:

 [Disclaimer: Past performance is not necessarily indicative of future results]

For years, managed futures has languished as the ugly stepsister of the hedge fund world, despite outperforming them during key stress periods like the 2008 credit crisis [Disclaimer: past performance is not necessarily indicative of future results]. Once more, it looks as though managed futures is proving that they’re just as pretty as their better known counterparts- if not more so.

We talked about this a lot in 2008, and it bears repeating here – hedge funds are a poor diversifier for traditional portfolios holding stocks and bonds.  We had this to say back in September of 2008:

The reason hedge funds have seen losses, on average, is because the grand majority of hedge funds do not offer true asset class diversification, and are really just diversifying the way they trade versus the what they trade. Venture capital, private equity, and many hedge funds (convertible arbitrage, long/short, dedicated short, emerging markets, & event driven funds) are actually an extension of the equity class (stocks), not an alternate asset class altogether. Just look at what many hedge funds do to generate their absolute returns (Hedge Funds explained).

Worse yet, many hedge funds rely on ultra cheap financing to place their leveraged bets. When that financing dries up, say in global credit squeeze, they can’t leverage up their trades, and their returns become tied to the credit cycles of the economy they are supposed to be independent of.

Further, we posted the findings of Welton Investment Corp. back in February from their excellent white paper:  “Diversification, Often Discussed, but Frequently Misunderstood”,  and summarized their findings as follows:

…eight out of 10 hedge fund strategy types, including private equity, event driven, and even fixed income arbitrage, behaving more like stock markets than we would expect them to under the alternatives moniker; and so called real assets like infrastructure and real estate again tied closer to equity market returns than one would expect from their marketing as non correlated to the stock market asset classes. If you are in any of the strategy types just mentioned thinking that you are diversifying your risk – these finding should keep you up at night. 

Their conclusion: it is time to ditch the old asset allocation model in favor of a more sophisticated model which allocates based on how different investments actually react to each other, not just on some arbitrary grouping by database providers and/or marketers of alternatives. Doing so may save those from disappointing performance amongst their ‘alternatives’ allocation the next time a 2008-type market rears its ugly head.

The point…. Hedge funds are good investments, and they provide better risk adjusted returns than a traditional portfolio (in our opinion). But they are not alternative investments that are likely to protect you against a drastic fall in stocks and recessionary economy. And they certainly won’t perform like managed futures will during a crisis.