Hedge Funds and Commodity Fund Investments in Bull and Bear Markets

This study examines the performance of sixteen different hedge fund and commodity fund investment styles during rising and falling stock prices over the period 1990:01 through 1998:08. Since a primary motivation for investing in hedge funds and commodity funds is to diversify against falling stock prices, it is important to examine the performance of these funds during bear stock markets. The study evaluates hedge funds and commodity funds both as stand-alone assets and as portfolio assets, and in both bull and bear stock markets. In addition, it utilizes the Sharpe ratio as well as alternative safety-first performance criteria to evaluate the funds. We conclude that commodity funds generally provide greater downside protection than do hedge funds. Commodity funds have higher returns in bear markets than do hedge funds, and generally have an inverse correlation with stock returns in bear markets, while hedge funds typically exhibit a higher positive correlation with stock returns in bear markets than in bull markets. However, three hedge fund styles - market-neutral, event-driven, and global macro - provide fairly good downside protection while still providing more attractive returns over all markets than do commodity funds.