Alexander D. Healy and Andrew W. Lo
Volume 7, Number 3, Third Quarter 2009
In response to the current financial crisis, a number of hedge funds have implemented gates on their funds that restrict withdrawals when the sum of redemption requests exceeds a certain percentage of the funds total assets. To reduce the investors risk exposures during these periods, we propose a futures overlay strategy designed to hedge out or control the common factor exposures of gated assets. By taking countervailing positions in stock, bond, currency, and commodity exposures, an investor can greatly reduce the systematic risks of their gated assets while still enjoying the benefits of manager-specific alpha. Such overlay strategies can also be used to reposition the betas of an investors entire portfolio, effectively rebalancing asset-class exposures without having to trade the less liquid underlying assets during periods of market dislocation. To illustrate the costs and benefits of such overlays, we simulate the impact of a simple beta-hedging strategy applied to long/short equity hedge funds in the TASS database.