Are Exceptional Hedge Fund Results Becoming Exceptional?

June 17, 2013

Hedge funds pursuing an equity strategy demonstrated year-to-date average returns of around 5.38 percent, comparing rather unfavorably with the S&P 500 year-to-date returns, which boasted gains of almost double this number.

Given this fact, why do investors continue to rely on hedge funds? Why do hedge fund assets under management continue to grow? Answers to these questions may be found, in part, in the pages of SEI’s Sixth Annual Global Survey. Senior investment professionals at more than one-hundred institutions around the globe participated. Endowments, foundations, family offices and pension plans comprised 46% of participants, and the remaining respondents represented funds of hedge funds, banks, insurance companies and non-profit organizations.

Regardless of Market Conditions

The working premise of the hedge fund is that hedge funds will show a return for investors regardless of market conditions. While this is a lofty goal, actual results parallel Abraham Lincoln’s famous quote, “You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time.” As it pertains to hedge funds, just replace “fool” with “earn for.”

It is understandable that individuals charged with the awesome responsibility of safe-guarding and growing pension funds, family fortunes, endowment funds and the like, will seek investment opportunities that promise relative safety and growth in a volatile market.

Hedge funds are the logical and, for most institutional investors, the best investment alternative available for significant percentages of the funds they manage.

Survey Results Confirm This

SEI’s 2012 hedge fund survey quantifies this in greater detail, but it suffices to say, the institutional investor’s average investment in hedge funds represents almost 15 percent of monies available for investment. Moreover, the survey shows that actual dollars invested increased around 70 percent from 2010 to 2012 and fully one-third of survey respondents indicated a desire to increase allocations to hedge funds in the coming year.

Results Vary by Strategy

2012 hedge fund results obviously favored funds pursuing an equity strategy, but whether or not 2013 will favor this strategy remains an open question. Clearly, institutional investors are not divorced from the decision making process. While they may entrust significant percentages of
their investment portfolios to hedge funds, the institutional investor is responsible for deciding which strategy offers the best growth prospect and
which hedge fund will most successfully exploit that strategy.

Finding Exceptional Performers

The greatest challenge facing the institutional investor is finding an exceptional performer among the thousands of hedge funds in existence today. Perhaps as a result, an increasing number of institutional investors are opting for “managed accounts.” With a managed account, the institutional investor retains greater control over the investment and is not forced to accept the investment mix of the broader hedge fund portfolio.

Managed accounts, however, shift the burden of performance back to the investor, which contradicts the principal objectives of hedge fund investment in the first place—mitigating risk and achieving alpha regardless of market conditions.

It is an undeniable fact that no definitive method exists for the institutional investor to select an exceptionally performing hedge fund or hedge fund manager.

 

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