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Apples and Apples: How to better understand hedge fund performance

Research paper finds that measuring hedge funds against the S&P 500 is a false comparison and is not the way most institutional investors judge hedge fund performance

 

In 2014, against the backdrop of a debate into hedge fund performance, AIMA published ‘Apples and Apples: How to better understand hedge fund performance’. The guide said that comparing hedge fund performance to the S&P 500 was an “apples and oranges” comparison and proposed five steps to improving understanding of hedge fund performance: 

Look at risk-adjusted returns: The guide revealed that hedge funds consistently outperform US equities (as measured by the S&P 500), global equities (MSCI World) and global bonds (Barclays Global Aggregate ex-USD Index) on a risk-adjusted basis, a crucial measure for investors. Even during the stock-market rally of 2009-2013, hedge funds performed better on a risk-adjusted basis than the S&P 500 and MSCI World. 

Look at long-term data: The guide said that short-term data such as monthly comparisons can be misleading and argued that greater clarity could be gained by looking at long-term figures. It pointed out that hedge funds outperformed the main standalone asset classes over the 10 years to the end of 2013 both in terms of “headline” returns and on a risk-adjusted basis. 

Look at the returns by strategy: The guide explained how hedge fund strategies are enormously diverse and have different characteristics which can play different roles in investor portfolios. It also stressed that hedge funds are not an asset class and that there is no such thing as the “average” hedge fund.

Compare with the most relevant asset class: The guide said that reference should be made to how different strategies perform in relation to the most relevant asset class to that strategy. In other words, it may make much more sense to be comparing a particular strategy to bond performance than equities.

Be aware of differences between hedge fund indices: The guide noted that during the five years to the end of 2013, the main hedge fund indices produced notably different results, reflecting variations in constituency and methodology.

 

Figure 6 1

 

Figure 7

 

Figure 8

 

 

Apples and apples

“Informed investors do not only look at ‘headline’ return figures. They often also look at ‘risk adjusted’ returns — a way of measuring the value of the return in terms of the degree of risk taken. They would often rather have steadier returns with lower volatility than higher ones with greater volatility, because of the risk of potential loss that higher volatility brings (as in 2008 when equity markets plunged).”

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