Executive Summary:

In March and May of this year, AQR published a compelling two-part critique of the Hedged Equity mutual fund & ETF space, authored by Cliff Asness and Dan Villalon. Their analysis resonated across the industry, particularly among managers in the Hedged Equity segment. As a manager of a Hedged Equity SMA strategy, one might expect me to take issue with AQR’s findings. On the contrary—I agree with much of their assessment.

Still, we saw room to add perspective. Using Morningstar data, we conducted a parallel analysis that includes both open-ended mutual funds/ETFs and SMA strategies. Our intent is to refine the lens through which investors evaluate this category—and help separate the large number of underperformers from the very few with genuine risk-managed merit.

Abstract:

Our analysis defined the Hedged Equity space with more granularity than the AQR analysis. We ran a similar AQR filter but also examined the fund prospectuses to ensure proper inclusion and added SMA managers. (page 2)

• AQR’s analysis of the Hedged Equity space was spot on – the majority of strategies materially under-perform the S&P 500 but do manage to serve their stated goal of reducing drawdowns. (page 2)

• Our version of the analysis affirms the AQR view: even when you adjust to analyze using the metrics that are more industry relevant (Capture Ratio, Sharpe Ratio, & Sortino Ratio), the publicly available Hedged Equity category is very weak overall. (pages 2-3)

• Only a handful of strategies deliver better risk adjusted returns than the S&P 500 while delivering the highest Capture Ratio in the space – including two strategies managed by Alpha DNA. (page 3)

• These top performing strategies had some generally common traits: active equity and options management, opportunistic hedging / profit reinvestment, & disciplined downside design. (page 4)

• The fees in this category are a material drag on the net returns in the space – which is disappointing given the underwhelming performance.  (page 4)

• Check out the Appendix for the graphs that parallel the AQR analysis starting on Page 6.

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