ASSOCIATION COLUMN: Of apples and oranges

Jack-InglisAt a time when many commentators have claimed that hedge fund performance is “disappointing”, investor satisfaction levels continue to rise. At the end of 2013, a Barclays survey of investors found that hedge fund performance for that year had been either in line with or better than the expectations of more than half of all institutional investors. A survey by Preqin in January 2014 found that more than 80% of institutional investors were satisfied with performance the previous year, despite the “average” hedge fund appearing to underperform the S&P 500. What gives?

Seeking to answer this question was one of the inspirations behind our research paper, Apples and apples: How to better understand hedge fund performance. What we found, we hope, has added fresh insight into a very old debate – how to understand hedge fund performance and compare it to other investments. 

Today it is still commonplace for comparisons between aggregated hedge fund indices and equities indices like the S&P 500 to be made. For example, a set of monthly hedge fund index figures is often compared to the S&P 500 in that period with the latter used as a proxy for the “market”, with the difference between the two interpreted as hedge funds either under- or over-performing the market.

In fact, comparing hedge fund returns to the S&P 500 can be an “apples and oranges”-comparison. Prior to 1990, the hedge fund industry was very largely based in the US and long/short US equity was one of the most common strategies. But the hedge fund sector today is now more global (Aima has members in more than 50 countries, for instance) and more diverse: investors in hedge funds have a choice of at least 20 different classes of investment strategy, many of which are designed to be uncorrelated to equity markets or do not invest in equities at all. 

Indeed, only a relatively small number of individual funds. Perhaps fewer than 20 of the roughly 374 hedge funds managing over $1 billion ( €734.9 million) are understood to be invested in US equities alone.

This is not, of course, the way most institutional hedge fund investors or funds of hedge funds measure the success of their allocations. They may have a particular return figure in mind for the hedge fund part of their portfolio – T-bills plus X, say – or be seeking to reduce volatility or provide downside protection. Just as there are many different hedge fund strategies, so there are many different things that investors are seeking from their hedge
fund allocations.

Investors are not allocating to hedge funds to beat the S&P 500, but to allow them to meet their asset-liability management objectives in terms of risk-adjusted returns, diversification, lower correlations, lower volatility and downside protection. Rather than merely chasing performance, many institutional investors use hedge funds and other alternative investment options as tools to customise their portfolios.

Jack Inglis Chief executive officer, the Alternative Investment Management Association (Aima)

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