A Regime Analysis of Hedge Fund Index Returns and Factor Loadings

Abstract

Regime-based investing has gained popularity due to its significant portfolio performance improvements by mitigating downside risk and boosting riskadjusted returns. In this work, we study its intersection with factor-based asset allocation models in the context of hedge fund indices. By employing a datadriven and model-free trend filtering approach to regime identification, this paper analyzes the returns, correlations, and factor loadings of 14 HFR indices under growth, transition, and crash regimes. Our results find three indices that serve as wealth protection investments and identify underlying risk exposures and return drivers of each hedge fund index. Several extensions to our model are discussed in the last chapter, including the optimization of a regime-switching factor-based portfolio to replicate hedge fund returns.