Structured credit traces its history back to the 20th century and has been a part of institutional and hedge fund portfolios for decades. Hedge fund managers focusing on structured credit could largely be dichotomised into those who generate returns from beta exposure to the asset class, and those who exploit mispriced instruments resulting from market inefficiency. Structured credit instruments result from the securitisation process in which multiple debt obligations are packed into interest-bearing securities whose cash flows are then sold to investors. This asset class has remained attractive to investors due to their ability to offer good return potentials and low rate of losses while providing diversification from other fixed income assets. The securitisation process also allows the final product to be tailored to an investor’s specific risk profile and constraints. On the other hand, the complexity of the instrument may result in heightened liquidity risk, and certain structured credit investment strategies may expose investors to basis risk arising from imperfect hedging using other fixed income assets.
The Eurekahedge Structured Credit Hedge Fund Index is an equal-weighted index comprising 76 active structured credit hedge funds collectively managing US$60.6 billion, and is designed to help institutional investors track the performance of structured credit hedge fund managers. The index has returned 8.12% throughout 2019, outperforming fixed income hedge fund managers who were up 7.73% over the same period. Structured credit hedge funds were up 4.19% in 2018, despite the multitude of geopolitical issues weighing on the performance of hedge fund managers in general.
Figure 1 below compares the performance of the Eurekahedge Structured Credit Hedge Fund Index against the Eurekahedge Fixed Income Hedge Fund Index, as well as the US high-yield bond and the global government bond markets represented by the Merrill Lynch US High Yield Master II Index and the Merrill Lynch Global Government Bond Index respectively.Figure 1: Performance of structured credit hedge funds against benchmarks since the end of 2005
As observed in Figure 1, structured credit hedge funds have managed to return 9.73% per annum, outperforming their fixed income peers, US high-yield bonds, as well as global investment grade bonds which returned 6.09%, 7.44% and 3.42% per annum respectively since the end of 2005.
Table 1: Performance in numbers - structured credit hedge funds against benchmarks
Eurekahedge Structured Credit Hedge Fund Index |
Eurekahedge Fixed Income Hedge Fund Index |
Merrill Lynch US High Yield Master II Index |
Merrill Lynch Global Government Bond Index |
|
|---|---|---|---|---|
2006 |
13.42% |
8.42% |
11.77% |
0.88% |
2007 |
3.42% |
5.12% |
2.19% |
3.93% |
2008 |
(18.31%) |
(10.99%) |
(26.39%) |
8.88% |
2009 |
35.04% |
25.10% |
57.51% |
0.86% |
2010 |
25.68% |
12.98% |
15.19% |
3.64% |
2011 |
5.05% |
4.41% |
4.38% |
6.09% |
2012 |
23.57% |
11.67% |
15.58% |
9.08% |
2013 |
14.80% |
5.88% |
7.42% |
(4.67%) |
2014 |
9.78% |
4.42% |
2.50% |
8.37% |
2015 |
3.59% |
1.06% |
(4.64%) |
1.22% |
2016 |
7.47% |
6.68% |
17.49% |
2.96% |
2017 |
10.03% |
6.53% |
7.48% |
1.16% |
2018 |
4.19% |
0.06% |
(2.26%) |
0.99% |
2019 |
8.12% |
7.73% |
14.45% |
5.39% |
3-year annualised return |
7.42% |
4.72% |
6.33% |
2.49% |
3-year annualised volatility |
1.82% |
1.74% |
4.20% |
2.82% |
3-year Sharpe ratio (RFR = 2%) |
2.98 |
1.56 |
1.03 |
0.18 |
5-year annualised return |
6.65% |
4.36% |
6.14% |
2.33% |
5-year annualised volatility |
2.45% |
2.07% |
5.35% |
3.19% |
5-year Sharpe ratio (RFR = 2%) |
1.90 |
1.14 |
0.77 |
0.10 |
10-year annualised return |
10.99% |
6.07% |
7.50% |
3.35% |
10-year annualised volatility |
3.48% |
2.58% |
5.82% |
4.10% |
10-year Sharpe ratio (RFR = 2%) |
2.58 |
1.58 |
0.95 |
0.33 |
Source: Eurekahedge
Table 1 provides the detailed risk return statistics of the four indices shown in the figure above. Key takeaways include:
- The Eurekahedge Structured Credit Hedge Fund Index returned 8.12% throughout 2019, narrowly outperforming fixed income hedge fund managers who returned 7.73% over the same period as they benefited from falling bond yields. Looking at 2018 returns, structured credit hedge fund managers were up 4.19% for the year, outperforming their benchmarks, as well as the global hedge fund industry in general.
- Structured credit hedge funds have consistently generated positive annual returns since the aftermath of the 2008 financial crisis. The strategy has also persistently outperformed the Eurekahedge Fixed Income Hedge Fund Index over the past three, five, and 10-year periods as shown in the table above.
- Hedge fund managers comprising the Eurekahedge Structured Credit Hedge Fund Index have generated exceptional Sharpe ratios over the past decade, outperforming their benchmarks by a notable margin. Over the last three years, structured credit hedge fund managers have generated a Sharpe ratio of 2.98. This figure compares against the 1.56 Sharpe ratio recorded by fixed income hedge funds over the same period.
However, it is pertinent to note that the returns of structured credit hedge funds exhibit stronger positive autocorrelation than those of fixed income hedge funds. The less liquid nature of structured credit instruments as opposed to other fixed income assets could have resulted in lower volatilities and higher Sharpe ratios.
Table 2 provides the correlation values between the performances of structured credit hedge fund managers against their benchmarks. As seen in the table below, the performance of Eurekahedge Structured Credit Hedge Fund Index is moderately correlated to the performance of fixed income hedge funds and high yield bonds, and has a very weak negative correlation against government bonds.
Table 2: Correlation matrix
Figure 2 provides the 12-month rolling alpha of the Eurekahedge Structured Credit Hedge Fund Index against both the Merrill Lynch US High Yield Master II Index, the Merrill Lynch Global Government Bond Index, as well as the Eurekahedge Fixed Income Hedge Fund Index, assuming a risk-free rate of 0%. Structured credit hedge funds generated significant negative alpha against the benchmark bond indices in the aftermath of the global financial crisis of 2008. However, as seen in the figure, structured credit hedge funds have been capable of generating positive alpha against the aforementioned benchmarks over most of the recent years.
Figure 2: 12-month rolling Alpha of structured credit hedge funds against benchmarks (RFR = 0%)
Figure 3 provides the performance distribution of all structured credit hedge funds in the Eurekahedge database, showing the median return, 10th and 90th percentile returns, as well as the top and bottom quartile returns on a yearly basis since 2006. It could be observed that return dispersion among structured credit hedge funds have fallen since the 2008 crisis.
Figure 3: Performance distribution of structured credit hedge funds
Following the global financial crisis of 2008, the structured credit market has withstood considerable changes which has made them more investor friendly, from greater structural provisions and investor protections, to stricter regulatory oversight. The shift from extremely risky instruments which featured extensively during the crisis to more conservative instruments, combined with improved due diligence from fund managers have allowed structured credit hedge funds to remain attractive to institutional investors seeking alpha and diversification.
The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.
Subscribers may continue to login as usual to download the full report and non-subscribers may email database@eurekahedge.com to enquire on how to obtain the full research report.
