Introduction

Eurekahedge recently launched a suite of new indices, under the name Mizuho-Eurekahedge Index, which are asset weighted and follow a new and unique methodology. In this report we highlight the key features of this set of indices, analyse the risk-return profile and show how the different statistical properties and analysis can be of use to hedge fund investors.

Key attributes of the methodology

• Asset weighted to provide a more representative market portfolio
• All hedge fund’s underlying local currencies converted to USD on a monthly basis along with 3 additional ‘currency hedged’ indices.
• Minimum AuM levels eliminate smaller funds that will not have a significant impact on the asset flows of the industry
• The new indices account for backfill bias by only taking into consideration the data of funds after they have listed on the Eurekahedge database – including all historical returns.
• The new indices account for survivorship bias by including historical performance of all the funds meeting the index criteria at each point in time even if the fund do not exist any more.

Performance Summary

Figure 1 displays the Mizuho-Eurekahedge Index and the Dow Jones World Index and Table 1 shows the corresponding risk return metrics.

Figure 1: Mizuho-Eurekahedge Index vs DJ World Index

When compared to the underlying equity markets¹ the Mizuho-Eurekahedge Index has witnessed better performance over the last six and a half years, with less than half the volatility and a low beta (correlation to the markets). Total return for the index stands at 50.27% as opposed to a 17.12% gain in the DJ World Index since December 2004. Funds within the Mizuho-Eurekahedge Index have also provided significant downturn protection – in 2011 the index is down only 2.03% (September YTD) compared to an average 13.74% decline in global markets. Since December 2004, the maximum drawdown of the Mizuho-Eurekahedge Index is 17.38%, while that of the DJ World Index stands at 54.38%.

Table 1: Risk-return statistics of Mizuho-Eurekahedge Index and DJ World Index

The Mizuho-Eurekahedge Index can be enhanced for specific regions, strategies and sizes to suit the requirements of investors. The Mizuho-Eurekahedge Asia Pacific Index, for example, tracks the assets and performance of hedge funds that are investing in Asia, and as such provides a comprehensive benchmark for the sector. Similarly the Top 100 index aggregates the assets of the largest 100 funds in the Eurekahedge database and tracks the returns of these funds. This index is rebalanced each quarter to reflect the performance of largest asset base in the hedge fund industry. Table 2 shows a comparison of the different indices within the Mizuho-Eurekahedge Index suite:

Table 2: Comparison of Mizuho-Eurekahedge Indices²

Turnover rates
Turnover rate implies the number of funds that are replaced in the index or a portfolio over the course of time. For this discussion we consider the Mizuho-Eurekahedge Top100 Index, which displays an average annually turnover rate 32%. This is calculated by taking the difference between the index constituents at the start of a year and the index constituents at the start of the following year. For example in any given year if you invest in 100 funds on December 31 you could expect to maintain holdings in 68 of those funds at the end of the year with 32 new funds in your portfolio.

Since the index comprises of only the largest 100 funds that report to the Eurekahedge databases, the primary reasons for fund turnover is:

1. funds increasing in assets to break into the top 100 (by AuM) and overtaking the AuM of existing funds within the index
2. new fund launches
3. closures of funds in the index previously

This suggests that the Top 100 Index broadly follows a momentum (or populist) strategy, where the larger and more successful hedge funds would be added to the index while the funds which lose capital (either through performance or asset flows) would be taken out of the index.

Table 3: Turnover rate of index constituents of the Mizuho-Eurekahedge Top 100 Index

The turnover rate was at its maximum during the 2008 financial crisis with 41% of the funds in the index at the start of the year being replaced by the year-end. This was primarily because of the heavy redemption pressure and large losses witnessed by many hedge funds during the year. Long/short equity, multi-strategy and distressed debt funds formed the majority of the funds that dropped out of the index as they posted the largest losses in 2008, while a significant number of CTA and macro hedge funds were added to the index as they protected their capital and also posted performance based gains, hence increasing their asset base. In contrast the turnover rate in 2009 was much lower at 25%, as most of the funds that had done well in 2008 attracted assets while also posting performance based gains.

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¹ Represented here by the Dow Jones World Index
² No. of funds and AuMs as of July 2011, Statistics calculated for the December 2004 to September 2011 time period