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Another Test of Hedge Fund Returns

| | Posted in: Mutual/Hedge Funds

Do most hedge funds outperform broad market indexes? Do some types of hedge funds do better than others? In their May 2006 paper entitled “The Performance of Hedge Fund Strategies and the Asymmetry of Return Distributions”, Bill Ding and Hany Shawky examine returns for hedge funds in general. They also use four alternative models to investigate the performance distributions of several categories of equity hedge funds, comparing results with broad stock market indexes. Using monthly returns over the period 1990 (466 funds with $16 billion in assets) to 2003 (2,225 funds with $328 billion in assets), they find that:

  • During 1990-2003, all equity hedge fund categories outperform the Wilshire 5000 index (similar raw returns but lower volatilities).
  • However, only 40-47% of individual hedge funds outperform over that time period (not very different from mutual funds).
  • Event Driven, Distressed Securities and Merger Arbitrage strategies perform considerably better than Emerging Markets, Equity Hedge and Global Macro strategies.
  • Aggregate analysis is probably an inadequate measure of the performance of the hedge fund industry.

The authors note that these results may include reporting bias, since hedge fund financial reporting is voluntary.

The following chart, extracted from the paper, summarizes monthly returns for several broad categories of hedge funds during 1990-2003, including both continuing (live) and discontinued (dead) funds. It shows that raw returns for equity hedge funds are comparable to those for broad stock market indices, though live hedge funds exhibit lower volatility. In accordance with common sense, live hedge funds outperform dead ones.

In summary, even though they outperform in aggregate, less than half of equity hedge funds outperform broad stock market indexes.

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