How to interpret fund performance data
Published: 18 December 2016
To understand performance in any meaningful sense several factors must be taken into account:
Investors in alternative investment funds typically want gains to be steady and low-risk over the long term. Hedge funds as a whole 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 measure of performance that is highly valued by institutional investors since it adjusts the return by the level of volatility. Even during the stock-market rally that followed the financial crisis, hedge funds performed better on a risk-adjusted basis than the S&P 500 and MSCI World.
Allocating to hedge funds allows investors to meet individual and more customised asset-liability management objectives in terms of risk-adjusted returns, diversification, lower correlations, lower volatility and downside protection. This may explain why investors have stayed loyal to their hedge fund allocations that many surveys have reported, even at a time when many commentators have been arguing the industry “under-performed” relative to the S&P 500. It suggests that many institutional investors prefer steadier returns achieved with lower volatility to higher returns achieved with greater volatility. Furthermore, the stock market rally of recent years will not last forever.
Since many alternative investment funds do not only invest in stocks and shares, it makes little sense to compare their performance overall to that of the stock market. It is common for comparisons to be made between aggregated hedge fund indices, as a proxy for all hedge funds’ performance, and equities indices like the S&P 500, as a proxy for “the market”. The difference between the two is then interpreted as hedge funds either under- or over-performing the overall market. But the hedge fund sector is extremely diverse, with at least 20 different investing styles and strategies, some of which do not even include equities, such as credit and debt funds. These strategies are also often designed to behave very differently to each other. Instead, when benchmarking hedge fund performance, investors tend to refer to the most relevant asset class, whether fixed income, commodities or equities.
Some of the most experienced investors are increasing their allocations to alternative investment funds as their primary equity, bond or credit strategy, rather than simply as complements to their “long-only” investments. Investors traditionally viewed alternative investment funds as a separate bucket, detached from traditional assets, such as equities. Increasingly, however, investors are seeing hedge funds as a substitute for long-only investments and diversifiers capable of transforming the risk and return characteristics of their entire portfolio.
Further readingApples and Apples - How to Better Understand Hedge Fund Performance (2014)
AIMA/CAIA: Portfolio Transformers - Examining the role of hedge funds as substitutes and diversifiers in investor portfolios (2015)