Portfolio Construction and Negative Correlation, from the Strategy HF uncorrelated perspective.
The concept of negative correlation is a key one in portfolio construction.
Negative correlation between x,y,z, criteria enables the creation of diversified portfolios that can better withstand market volatility and smooth out portfolio returns over the long term. The building of hedge fund portfolios where the correlations are carefully balanced to provide more predictable volatility is a necessary discipline in that respect.
Therefore, this evaluation and comparative process is an important part of the Strategy HF Uncorrelated investment process.
This evaluation can take place from 2 main vectors. One is ex-post and tends to rely on historical data (track record), the other would be considered as ex-ante and relies on the identification of the funds trading style and risk profile. So, when sufficient track-record is available it can be used as the first level of analysis to identify the correlation profile of a fund vs. its peers, and other positions within the Strategy HF Uncorrelated portfolio, so to minimize the risk of convergence in specific market situations. When there are not enough data to validate the quantitative approach, understanding the fund risk profile and trading style when deploying its strategy can be a strong indicator of forward correlation to many designated markers we decide to track to maintain the Strategy HF Uncorrelated overall risk-return profile.
The first table provides an instant view of the underlying funds relations from a correlation point of view. The more negative correlation shows up the better and the more robustness can be expected. In our view, for a fund of funds like the Strategy HF Uncorrelated it is preferable to maintain the majority of correlations below 0.50 so to maintain the integrity of the risk-return profile of the portfolio. The more negative correlations show up… the even better, but not an easy task.
The second graph is a representation of the diversity of risk return profiles we hold in the portfolio and where the portfolio itself stands. It provides a visual perception of the dispersion of risk profiles of underlying funds, and the outcome of the aggregate when looking where the Portfolio seats.
These two graphs are available on a monthly basis in the Strategy HF Uncorrelated reporting.
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