The case for hedge funds.

I am overall quite critical of the hype that surrounds the hedge fund industry and quite sceptical of the returns on indexes that are so frequently published without any critical evaluation. However, I do think that a properly managed hedge fund has the potential to be a much more intelligent investment than a more traditional actively managed fund.

The problem with the normal fund model is that, although paying a premium for a manager’s presumed abilities to beat the market, the manager is effectively working in a highly restrictive straight jacket of being long only. Even when actually able to beat the market, this must be limited and partially offset by the fee structures. On average, it is better to simply buy the index and follow the market.

But there are clearly returns to be made out there and a hedge fund provides the manager with the ability and the incentive to find them. Without the long only constraint the manager is also free to pursue strategies which may have a low or negative correlation to the market itself. In my opinion, a sound asset allocation might be around 70% in a low fee index tracker and the remainder in a non correlated fund or fund of funds.

Credit Suisse Tremont Hedge Fund Index

 

Hedge Fund Index

Originally uploaded by graven1.

OK here is a more illuminating graphic.

Hedge Fund Returns ‘are vastly overstated’ – Barclays Capital

Not much of a surprise really, was it? Survivor bias, selection bias and instant history bias which should all have been expected in hedge fund indices are likely to be having an effect.

These basically mean that when fund implode or are discontinued, they drop out of the indices. Funds with no reporting requirements choose only to report those that perform well. And when they do report them, the sucessful fund’s history is added back into the indices’ past performance. A recipe for showing apparent success, really. What is surprising is by how little they are beating share indices, though of course they shouldn’t be compared as they should be pretty much uncorrelated.

http://business.timesonline.co.uk/article/0,,9063-2061766,00.html

Hedge Fund Indices

An interesting article on Hedge Fund Indices Most specifically focused on why an index is an apealing idea, but a fairly complicated thing to put together in new investment category which lacks tranparency.

Overview of Hedge Fund Strategies

An interesting basic report on the basic strategies from www.global-derivatives.com

Credit Suisse/Tremont Investable Hedge Fund Index 2005

Looks like another good performance by the sector – but I think the net figures might be a little less flattering. Sourced from this article.

Performance and Risk Statistics (Gross)*
(January 2004 – December 2005)

	Dec-05	2005 YTD	ITD**	2004
INVX	0.58%	4.41%	10.89%	6.20%
MSCI	0.99%	4.68%	7.93%	3.10%
S&P	0.60%	2.74%	6.79%	3.95%
HFRX	1.48%	2.72%	5.49%	2.69%
DJHF	0.64%	2.35%	7.78%	5.31%
FTSE	1.23%	2.60%	5.34%	2.67%

*For the purposes of this chart, INVX returns are presented on a gross basis.
** ITD represents the cumulative return from January 2004 through December 2005.

Hedgehogging by Barton Briggs

Hedgehogging seems like a very interesting read, it got a great review in the Economist. Basically the story of Briggs who, at age 70, tried to set up a hedge fund. Sounds very interesting.