This study shows that the performance of hedge funds has deteriorated in recent years


There have been plenty of headlines suggesting that hedge fund performance has slowed over the past 10-15 years, but now a new study brings those headlines beyond the anecdote. Nicolas PB Bollen, Juha Joenvaara and Mikko Kauppila examined the performance of hedge funds compared to other asset classes between 1997 and 2016. From 2008 to 2016, hedge funds began to lag behind traditional equity and bond portfolios following the global financial crisis.

Study results

To assess the performance of hedge funds, Bollen and his team examined six commercial return databases during the two time periods. They found that their equally weighted hedge fund index had a cumulative return of 225% over the first ten years, significantly outperforming an equally weighted stock and bond portfolio that had a cumulative return of 125%.

However, the hedge fund portfolio only returned 25% between 2008 and 2016, while the equity and bond portfolio rose 70% despite the sharp decline in the equity markets during the financial crisis. Bollen and his team also found positive Fung and Hsieh alpha a significant decrease in the means.

Twenty percent of hedge funds had positive, significant alpha between 1997 and 2007, but that percentage dropped to 10% in the second time frame. In addition, the proportion with clearly negative alpha increased from around 5% to around 20% in some cases.

Problems with hedge fund indices

In an email interview, Bollen explained why they used multiple hedge fund indices to determine hedge fund performance over the two time periods. He said returns are positively skewed as hedge funds with poor returns are less likely to report to an index.

“It has been shown that the overall performance of hedge funds is skewed upwards by relying on only one of the commercial databases, as the better-performing funds report to all databases while the poorer-performing funds report to only one Database reports, “explains Bollen.

“As a result, funds that are performing well are over-represented in a sample from a single database. Therefore, we need to use the consolidated database before we perform an industry performance assessment.”

Problems with stimuli

One of the reasons hedge funds have had a difficult time over the past 12 years is expansionary monetary policy. The enormous amounts of stimulus over the past year have posed a huge problem for hedge funds.

“As we show in the paper, the quantitative easing orchestrated by the US Federal Reserve is linked to increased correlations between individual stocks, stock indices and hedge funds,” said Bollen. “These high correlations make it more difficult to implement security selection and long / short strategies than with low correlations. In addition, the flood of liquidity has deliberately lowered returns at all levels, likely leading to over-the-top stock valuations, and bond investments have done very well and are a hard-to-beat benchmark. “

Why hedge funds still have a place in investor portfolios

Although hedge fund performance has declined over the years, Bollen argues that they still have a place in investor portfolios.

“We still find that the alpha of Fung-Hsieh’s seven-factor benchmark and the macro-timing measure of Bali, Brown and Caglayan (2014) are helpful in identifying a number of funds that have a diversification advantage offer ”, explained Bollen. “Our tests are conducted on a post-fee basis, which suggests that even after fees are factored in, investors can benefit from an allocation to hedge funds in the form of lower overall portfolio volatility since 2008, a blow to average returns. This means that only investors with a significant risk aversion will find the trade-off between risk and return a good deal. ”

Choosing the best hedge funds

Because of the diversification advantage that hedge funds offer, Bollen doesn’t think they’re going to go away. He noted that the industry’s assets under management are now at record highs and he doesn’t think passive funds will beat actively managed hedge funds forever.

“With bond yields near historic lows and stock valuations at historic highs, it seems unlikely that passive investments will be able to generate the same returns in the future that have made it so difficult to beat in the past,” he said. “Institutional investors who forecast lower returns on the equity and bond markets will likely find it best to continue investing in alternatives such as hedge funds, private equity and real assets.”

Bollen also has some advice for investors trying to choose hedge funds for their portfolio.

“The best predictors of performance seem to be related to past alpha,” he said. “In a broader sense, we think a manager’s long-term track record and proven ability to withstand shocks like we saw last spring should be a top priority for investors when choosing funds.”


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