Consider the census of 4,000-plus reporting managers tracked in Exhibit 4. By universe, the chart estimates statistical effects of the exposure for each of several thousand managers after accounting for other headline risk factors specific to each strategy. On the chart, if a point is aligned with 15% on the y-axis, and 86% on the x-axis, it indicates that 15% of a manager's return can be explained by VIP-VISP exposure, and by that amount, it would be larger than 86% of other managers within that universe.
In other words, it gives a sense of distribution and scale: Where does the exposure tend to occur and how large is it?
Not surprisingly, exposure is significant for “equity hedge,” particularly for U.S. and global U.S.-based managers (but not global ex-U.S. managers). All strategies, however, reflect some degree of exposure. That includes strategies such as macro, which are not characterized by single-name stock selection. For investors constructing multimanager portfolios, however, it is meaningful that the fund-of-funds strategy demonstrates the most widespread and significant exposure, including relative to the equity hedge index itself. In that the beta risk represents exposure to other hedge funds, it makes sense that the fund-of-funds strategy would be the most sensitive to this risk. It also underlines the significance of this form of exposure for investors constructing multimanager portfolios.
This carries several practical implications. First, it is worth repeating — emphatically — that the VIP index outperforms broad equities over time, which puts a sort of asterisk on efforts to manage the factor risk it represents; as far as systematic risks go, it is, in many ways, relatively attractive. It is equally notable, however, that so-called conventional risk factors, such as small cap and value, also tend to perform positively over time (based on Fama-French SMB and HML factors). All of this suggests that this risk, too, is worth measuring and monitoring, and can improve and validate hedge fund portfolio diversification.
For investors in multimanager hedge fund portfolios, a few conclusions suggested by the evidence are:
- Some position overlap might be inevitable in a multimanager portfolio, but the degree of exposure can vary greatly among strategies and managers.
- Such exposure might be considered favorable over time, as suggested by the long-term outperformance of the VIP vs. the S&P 500.
- However, “popular” in benign conditions can become “crowded” in times of stress.
- It makes sense for investors in multimanager portfolios to measure and manage “popular position” factors as a form of beta exposure.
Kristofer Kwait is managing director and head of research, and John Delano is director-hedge fund strategies group, with the Commonfund in Wilton, Conn.