Managerial Finance

Purpose – The purpose of this paper is to investigate the return performance of different investment strategies in the hedge fund sector, with a particular emphasis on the recent US financial crisis of 2007-2010. Additionally, the paper aims to investigate the comovement of hedge fund index returns.

Design/methodology/approach – The paper identifies broad hedge fund investment strategies using data from the Dow Jones Credit Suisse Hedge Fund Database. It examines the return comovement using the cross-sectional volatility, covariance, and correlation metrics proposed in Adrian (2007). In addition, the paper examines whether correlations and covariance are important determinants of future volatility via traditional time-series regressions.

Findings – The paper finds that the majority of the broad hedge fund investment strategies incurred record level losses and gains during the 2007-2010 period. In addition, it finds that the crisis period was preceded by high correlations, attributed primarily to a rise in cross-sectional hedge fund covariances. However, during the crisis period, a decrease in average correlations, stemming from an increase in hedge fund volatility, is documented. The time-series regressions are supportive of a strong relationship between cross-sectional covariances and subsequent volatility, suggesting that systemic risk occurs in the hedge fund sector when returns move significantly in dollar terms.

Originality/value – This study is one of the first investigations that focus on the comovement and volatility of hedge fund index returns during the US financial crisis of 2007-2010.