15 May 2023 Commodities | Equities | FX

The Inflation Effect on Hedge Funds

Summary

PivotalPath examines the performance of hedge fund indices under different inflation regimes.
While most major hedge fund indices performed worse under high inflation, the differences are small versus the stark drop in performance for the S&P 500.
Both the PivotalPath Managed Futures and Volatility indices produced slightly better returns during elevated inflation, while differences in Global Macro, Credit and Multi-Strategy indices were small.

Price Rises Persist

Inflation has occupied the minds of the Federal Reserve and U.S. consumers since the term ‘transitory’ admittedly became out of step almost a year and a half ago. And rightfully so, as inflation directly affects everything from consumer purchasing power to company profit margins. Additionally, policy responses to persistent inflation, such as raising interest rates, can have knock-on effects on the economic conditions and risk premia.

Inflation Effect on Hedge Fund Performance

We look at realized manager returns conditioned on low/high inflation regimes. As a substitute for manager returns, we use the PivotalPath Indices, while we use the 12-month percentage change in the Core Consumer Price Index (CCPIY) as a proxy for inflation. Our data covers January 2000 to December 2022 (Table 1).

As we can see, some effects are substantial and deserve closer inspection. The spread is economically meaningful for the S&P 500 Index, although the differences in aggregate hedge fund performance are not statistically significant (at a 5% confidence interval).

Since 2000, the level of CCPIY has coincided with large differences in the performance of the S&P 500 Index – historically favouring many hedge fund strategies. Here are some core observations:

The PivotalPath Hedge Fund Composite Index’s annualized performance was approximately 200bps lower in the higher inflation regime.
However, while most major hedge fund indices generated lower performance during higher inflation periods, the differences are relatively small versus the stark drop in performance for the S&P 500 Index.
Both the PivotalPath Managed Futures and Volatility Indices produced slightly better returns during elevated inflation, while differences in Global Macro, Credit and Multi-Strategy Indices were small.

What Can We Learn From This?

While historical data is never completely indicative of future performance, it can be informative, especially when representing changes to structural inputs such as inflation.

As inflation remains elevated well above the Fed’s comfort zone, representative Hedge Fund Indices and proper context should serve as a valuable guide to asset and strategy allocation.