Weak Results Dim Hedge Funds’ Luster

[DesertCat]

It's a little unfair to pick on hedge funds for a soft 9 month run, but that's the bed they chose. Clients apparently expect consistent market beating performance and the article talks about how quickly funds are closing when they achieve mediocre (but not terrible) returns.

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Returns for many hedge funds, which are supposed to be the market beaters, have paled in comparison with stocks. Hedge Fund Research’s weighted composite index is up 7.23 percent through September, according to a preliminary estimate, compared with the Standard & Poor’s 500-stock index, which, with dividends, has a total return of 12.4 percent over the same period.

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Of course the Hedge Fund Research index is also probably overstating hedge fund results, due to survivorship bias. If a fund stops reporting monthly results, they just drop it. Funds with great monthly results are probably less likely to stop reporting than funds with bad monthly results.

Full New York Times Article.

[eastbay]

Let me guess, they will either learn the principles of Warren Buffett or they will never succeed?

eastbay

[DesertCat]

[ QUOTE ]
Let me guess, they will either learn the principles of Warren Buffett or they will never succeed?

eastbay

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Well the principles of Warren Buffett won't hurt their performance But my bigger point is it's a tough business, and client expectations are high. 9 months is meaningless, but over longer periods most hedge funds appear to trail the indexes. If you want to invest in a hedge fund, it's important to get one of the real top managers who outperform over long periods, and not get stuck with one of the many pretenders.

[pig4bill]

[ QUOTE ]
Let me guess, they will either learn the principles of Warren Buffett or they will never succeed?

eastbay

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nh

[edtost]

[ QUOTE ]
but over longer periods most hedge funds appear to trail the indexes. If you want to invest in a hedge fund, it's important to get one of the real top managers who outperform over long periods, and not get stuck with one of the many pretenders.

[/ QUOTE ]

why should the many market-neutral funds out there be compared to any index at all?

[NajdorfDefense]

[ QUOTE ]
[ QUOTE ]
but over longer periods most hedge funds appear to trail the indexes. If you want to invest in a hedge fund, it's important to get one of the real top managers who outperform over long periods, and not get stuck with one of the many pretenders.

[/ QUOTE ]

why should the many market-neutral funds out there be compared to any index at all?

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After fees, the majority of hedge funds beat the indexes, and by a whopping margin if normalized to 100% long, like a passive index. I demonstrated this earlier, using real numbers.

Alpha per HF strategy, Ibbotson and Chen 1995-2006:
Equity Neutral +1.94%
fixed Inc Arb +3.91%
L/S Equity +5.41%.

A 100% long index that returns 10% CAGR is not 'outperforming' a 50% net long fund that returns 9% CAGR, not in any meaningful sense of the word.

Otherwise the best 'index strategy' would be 200% long and levered, etc.
Secondly, a 100% net long fund will, by definition, be down in down markets, there is no hedging/shorting available. Most great hedge funds make their real $ in bear markets, as everyone knows. You don't need them when the SPX is up 25%, you need them when it is down 23%.

Sharpe Ratios and Information Ratios are also significant, Mkt Neutral is 2.70 Sharpe, as an example. Event driven is 3.41 Info. L/S equity is 2.49, etc, etc.

[DesertCat]

I've never heard any hedge fund clients say they bought hedge funds so they can trail indexes. And what's the point of outperforming during the occasional bear market, when you underperform over all periods combined?

And how many hedge funds "hedge" any more? Greenblatt doesn't. I doubt Einhorn does. "hedge fund" has become a generic term for investment partnership. These partnership have all sorts of different strategies, some involving hedging, some not. But clients still have the same belief, that they are investing in a prestigious vehicle that's going to consistantly deliver strong returns, and beat the market over time. That belief seems to be misplaced for a majority of the funds.

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Consider a study by Roger Ibbotson, founder of Ibbotson Associates -- now a unit of Chicago researchers Morningstar Inc. -- and Peng Chen, the firm's president.

The authors note that, based on the TASS database, hedge funds appear to have clocked an eye-popping 16.5% a year between year-end 1994 and April 2006, easily outpacing the 11.6% average for the Standard & Poor's 500-stock index. Yet this 16.5% average is mighty misleading, for two reasons.

First, when hedge funds are added to performance databases, they sometimes include earlier results. This "backfill bias" skews the average upward, because only funds with stellar returns typically report their prior performance. Second, when poorly performing hedge funds go out of business, their dismal results are often ignored, leading to so-called survivorship bias.

What happens if you eliminate survivorship and backfill bias? Messrs. Ibbotson and Chen calculate that hedge funds returned just 9% a year, less than the S&P 500's 11.6%.


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reference link...

[ISF]

[ QUOTE ]
And what's the point of outperforming during the occasional bear market, when you underperform over all periods combined?

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This makes no sence. If people didnt care about risk no one would ever invest in bonds and would just own leveraged stock portfolios. The reason you need to normalize their returns is because its basically free to just use a futures overlay and generate the same risk profile as a long only stock portfolio. Therefore if they are providing alpha after fees then they are doing their job. As well most of the money going to hedge funds is institutional and they in general do not expect equity like returns from their hf investments.