Hedge Fund Performance Figures: 3 Things to Keep in Mind

There's more to hedge funds than tracking the S&P 500

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Jan 09, 2020
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Hedge funds have attracted a lot of criticism in recent years due to falling returns and high fees compared to the level of profits they are producing for their investors.

After several years of lackluster returns, investors have been pulling their money from hedge funds around the world, and in some cases, this money has gone straight into passive index tracker funds or exchange-traded funds.

However, according to preliminary trading data, hedge funds produced their best performance since the financial crisis in 2019.

The best performance since 2019

According to the hedge fund data provider HFRI, the HFRI Fund Weighted Composite Index gained 1.8% in December, taking it to an overall gain of 10.4% for the year. The last time the index produced a double-digit return of this size was in 2009. That year, the HFRI Fund Weighted Composite Index gained 20%.

Unfortunately, despite this high gain, hedge funds underperformed the wider market in 2019, with the S&P 500 index returning 31.5%. In fact, hedge funds on average only just outperformed bonds according to this data. Last year, the Barclays Capital Government/Credit Bond Index produced a total return of 10.1%. Hedge funds only outperformed by 0.3%.

These numbers only add to the argument that hedge funds do not provide value for money, and passive index tracker funds are generally better investments.

Figures are misleading

Having said all of the above, in many ways, these figures are misleading.

For a start, these are only average estimates, and we will not know the true performance figures until we have fourth-quarter and full-year results, which should start to come out in the next few weeks.

However, we will never know the exact performance figures for every hedge fund. For example, Seth Klarman (Trades, Portfolio)'s Baupost does not make its numbers public. While it is possible to estimating the performance of the hedge fund's equity portfolio based on its 13F filings, these figures only account for around a third of Baupost's total assets under management.

Hedging risk

Secondly, comparing average hedge fund performance figures to the broader market does not make much sense because hedge funds, as the name implies, design their portfolios to lessen, or hedge, risk. Moving back to the example of Baupost, we know Klarman has bought a vast array of esoteric assets over the past decade, including real estate, bankrupt company debt, and insurance claims, investing wherever he finds value.

These assets are unlikely to produce the same kind of returns as the stock market will over the long term, but Klarman is only targeting positive absolute returns.

Different strategies

Third, different hedge funds are designed to follow different strategies. Risk parity funds achieved a much better performance in 2019. The HFR Risk Parity Vol 15 Index rose 30.6% last year, nearly matching the performance of the market.

Other hedge funds, notably those that follow a bearish strategy, such as Crispin Odey's Odey Asset management, lost money. Odey is reportedly down more than 10% for 2019. However, in 2018, his funds surged more than 50%, outperforming the S&P 500's negative returns.

Conclusion

All in all, it is interesting to follow statistics for the hedge fund industry, but it is essential to keep in mind that this industry is not designed to match or replicate the performance of the S&P 500.

We only have limited data on the performance of many hedge funds, and looking at one single figure fails to take into account the fact that all of these funds follow different strategies and are aimed at different investors.

Hedge fund investors typically own a basket of different funds, all of which have different goals and objectives, diversify risk and help improve returns over the long term. Interpreting the industry as one fund that needs to beat the S&P 500 does not make much sense at all.

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