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Jumping the Gates: Using Beta-Overlay Strategies to Hedge Liquidity Constraints

Journal Of Investment Management (JOIM), Third Quarter 2009

Posted: 22 May 2009 Last revised: 3 Aug 2011

Alexander D. Healy

AlphaSimplex Group, LLC

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Date Written: May 19, 2009

Abstract

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 fund’s total assets. To reduce the investor’s 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 investor’s 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.

Keywords: Hedge funds, illiquidity, hedging, hedge fund beta, gates

Suggested Citation

Healy, Alexander D. and Lo, Andrew W., Jumping the Gates: Using Beta-Overlay Strategies to Hedge Liquidity Constraints (May 19, 2009). Journal Of Investment Management (JOIM), Third Quarter 2009. Available at SSRN: https://ssrn.com/abstract=1407382

Alexander D. Healy

AlphaSimplex Group, LLC ( email )

One Cambridge Center
Cambridge, MA 02142
United States
617 475-7100 (Phone)

HOME PAGE: http://www.alphasimplex.com

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

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