Hedge funds have increasingly aligned with equity markets, raising concerns among investors about their capacity to safeguard assets during potential market downturns. Recent research by BNP Paribas highlights a notable surge in correlation between hedge fund returns and the MSCI World index, which tracks a broad spectrum of global equities. The correlation, reaching its highest level in five years, comes in the context of a lucrative three-year bull market that saw hedge funds achieving a robust 12.5 percent return in 2025—marking their most successful year since 2009.
This pattern has drawn attention to a longstanding worry regarding high-fee hedge funds, which typically charge management fees of about 2 percent in addition to performance fees of 20 percent. Traditionally touted for their ability to minimize risk during market drops, the recent high correlation with equity markets calls into question their effectiveness in providing the promised protection.
Jon Caplis, founder of the hedge fund research firm PivotalPath, expressed concern about the potential ramifications of this correlation, referencing past instances when such alignment exacerbated significant sell-offs. He emphasized the necessity for investors to assess their overall equity exposure and ensure that it aligns with their current risk appetite.
Last year, hedge funds saw an influx of capital as investors shifted their focus from private equity. Inflows reached levels not seen since 2007, despite the industry grappling with the implications of high correlations to stock market movements. Equity long-short hedge funds, which employ strategies to profit from both rising and falling stock prices, recorded an astonishing correlation of 0.98 with market returns—the highest since data collection began in 2019. This figure compares to a three-year average of 0.92 and a five-year average of 0.86, where a correlation of 1 indicates perfect synchronicity.
Overall, the hedge fund industry exhibited a correlation of 0.92 with the MSCI World index, surpassing the five-year average of 0.76. PivotalPath’s research corroborated these findings, revealing an uptick in correlations between hedge funds and the S&P 500 index, which recently achieved record highs exceeding 7,000 points.
Concerns about lofty valuations, particularly in the artificial intelligence sector driving the current market rally, have prompted discussions about whether existing hedging strategies can truly offer adequate protection in the event of a sudden market downturn. Marlin Naidoo, global head of capital introduction at BNP Paribas, underscored the importance of evaluating the risk profile of hedge fund managers within investment portfolios.
Historically, high correlations among hedge funds and market indices have led to adverse outcomes for investors during declines, as witnessed in 2022 and 2011. The BNP Paribas data stemmed from insights gathered from 246 hedge fund investors who collectively managed $1.1 trillion in assets, analyzing monthly average returns against the MSCI World index.
Interestingly, discretionary macro funds—those that take positions based on macroeconomic indicators—demonstrated a relatively low correlation of 0.3. Meanwhile, the last notable spike in correlation for multi-strategy hedge funds occurred in September 2011, coinciding with the Eurozone debt crisis, and preceded another substantial market sell-off.
Caplis warned that these rapid shifts could be swift and severe, urging investors to remain vigilant in monitoring their hedge fund exposures amid changing market dynamics.
