Correlation Dilemma To Hamper Brains

"Drive thy business or it will drive thee"

Benjamin Franklin (1706 - 1790)

According to reports, Mitsubishi Asset Brains Co., the investment advisory arm of one of the largest city center banks in Japan is launching a fund of hedge funds. This time around the focus is on non-correlated returns. Now there is a novelty! This is like saying for the vast majority of the FoHF product range they are not currently focused on that as a starting point of their very existence. Odd indeed.

The fact of the matter is, finding managers with returns uncorrelated either to equities or fixed income is becoming more and more difficult. A recent diagram in a Lipper hedge fund report showed clearly the dilemma facing Nishi-san and his multi-billion dollar plans: correlations over the bulk of 6-month, 12-month and 36-month time horizons across 13 of the Credit Suisse/Tremont hedge fund sub-strategies point to GROWING correlation against the MSCI World Index. This is to be expected in time of market stress.

Only 4 of them showed solid non-correlation over the 6-month period. These were: Dedicated Short Bias, Global Macro, Equity Market Neutral and Managed futures. But over the longer 36-month time period even 3 of these "exceptions" proved to be positively correlated.

The bulk of sub-strategies exhibit a correlation with the MSCI World Index of between 0.6 to 0.85 which are high readings.

Which leads to the second dilemma, which is that if you are pretty much restricted to directional strategies are you not simply just offering a niche fund of funds with capacity limitations? That is what it sounds like to me.

Would it not be simplier and more cost effective to simply hedge against the MSCI World in order to achieve ones goal of non-correlation, and, at a sigificantly reduced cost?

Moreover, during the last 18-months there have been factors such as liquidity and deleveraging that have contributed to the apparent fall in correlation in some strategies such as with Equity Market Neutral - rather than being some fundamental shift in assets.

All told then, perhaps this "new" product is better described as yet another niche FoHF product designed to soak up institutional assets in Japan - something that is becoming increasingly difficult given the poor performance of a vast majority of products. You will certainly need sharp brains to sort this puzzle out. Mahalo.