Hedge Fund Factor Exposure & Alternatives

Alternatives to Alternative Investments?

November 2017. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Equity hedge fund returns have been disappointing over the last 14 years
  • An exposure analysis shows no structural factor exposure, but frequent factor rotation
  • Multi-factor long-short products are an interesting alternative, depending on the fee level


Hedge fund assets reached an all-time high in 2017 with $3.3 trillion under management. Although returns were muted in recent years, investors have an interest to hedge equity risk given high equity multiples, record levels of debt and political uncertainties. However, the future of hedge funds, specifically of equity hedge funds, can be considered somewhat less attractive. Similar to the disruption of the mutual fund industry by plain vanilla and smart beta ETFs, equity hedge funds are increasingly being replaced by systematic, cheap, and transparent factor products. However, it is questionable how effectively hedge funds can be replaced with long-short factor products. In this short research note we will analyse the factor exposure of equity hedge funds and compare the performance to a multi-factor long-short portfolio.


We focus on the HFRX Equity Long / Short Index (Equity Hedge), HFRX Equity Market Neutral Index and the following factors: Value, Size, Momentum, Low Volatility, Quality and Growth. The factors are constructed as beta-neutral long-short portfolios by taking the top and bottom 10% of the US stock universe and include 10 bps of transaction costs (read Factor Construction: Beta vs $-Neutrality). The factor exposure analysis is a simple regression analysis with a one-year lookback.


Before we start analysing the factor exposure of equity hedge funds it is worth highlighting the performance of both indices. We contrast the performance to the S&P 500, which should not be considered as a benchmark for hedge funds, but merely serve as a reference point for the market cycle. We can observe that the Equity Long / Short Index, which tends to have some market exposure, generated a total return of 24.5% from 2003 to 2017 (1.5% pa); a somewhat disappointing performance given that this return i