Lies, damned lies and hedge fund performance statistics

The shine appears to have gone hedge fund performance in recent years, at least compared to the glory years of the 1990s. Indeed hedge funds have posted negative returns in two of the past four years (2008 and 2011).

Nonetheless according to a new report produced by The Centre for Hedge Fund Research at Imperial College London commissioned by KPMG and the Alternative Investment Management Association (AIMA) hedge funds still outperformed equities, bonds and commodities over the 17 years from 1994 to 2011.  

The report, entitled “The Value of the Hedge Fund Industry to Investors, Markets and the Broader Economy”, found that hedge funds generated annual returns of 9.07 percent net of fees over the period, compared to 7.18 percent for global stocks, 6.25 percent for global bonds and 7.27 percent for global commodities. Moreover, hedge funds achieved these returns with considerably lower risk volatility as measured by Value-at-Risk (VaR) than either stocks or commodities. Indeed, hedge funds’ volatility and VaR came in at level similar to bonds. The research also demonstrated that hedge funds were significant generators of “alpha”, creating an average of 4.19 percent per year from 1994 to 2011.

“This research is powerful proof of hedge funds’ ability to generate stronger returns than equities, bonds and commodities and to do so with lower volatility and risk than equities,” said Andrew Baker, AIMA’s chief executive. “The most interesting point to come out of this research is that it disproves common public misconceptions that hedge funds are expensive and don’t deliver. The strong performance statistics, showcased in our study, speak for themselves,” added Rob Mirsky, KPMG’s UK head of hedge funds.

Or does it? Mr Baker’s claim may be somewhat disingenuous because on this writer’s reading of the report The Centre for Hedge Fund Research are not comparing like with like. Hedge funds typically employ leverage, which can magnify returns. The market indices used to measure the performance of global bonds, equities and commodities do not.

Leverage levels have probably fallen considerably in the wake of 2008’s global financial crisis. But according to Credit Suisse, for example, global hedge funds were still 2.52 times leveraged at the end of 2010. And this would almost certainly have had a significant impact on returns. It could easily more than explain account for the return differential, especially relative to global commodities and equities.

   

This is certainly the case for private equity, another “alternative” investment. At first sight returns from a typical private equity appear to outperform equity indices, such as the FTSE All Share Index. Lever the index to the same level of private equity fund and the situation is reversed.