First: Do No Harm

August 17, 2014

There are equivalencies that can be drawn between the physician’s Hippocratic Oath to patients, and the hedge fund’s primary responsibility to its clientele.

Just as the physician pledges to do no harm, the hedge fund manager has a similar charge with respect to preserving the investor’s capital. Don’t lose any principal! Of course, along with the concept of hedge funds as preservers of wealth, is the notion that hedge funds are multipliers of wealth.

While these two objectives are not mutually exclusive, the client’s focus on capital preservation in volatile markets, and expectations of growth in all market conditions are a significant challenge for any hedge fund manager.

In the Beginning

Alfred Winslow Jones, credited with founding the first hedged fund in 1949, was focused on investing in a manner that avoided wild swings in the market. In short, protecting invested funds against market volatility was the fund’s foremost goal. This was achieved by employing the now classic equity long-short strategy.

Hedge Funds in the Short-term

Recently, hedge funds have been on the receiving end of significant criticism because many are under-performing as compared to an arbitrary benchmark index—the S&P 500. Often overlooked, is the fact that a significant percentage of so-called hedge funds, are not “hedged” at all. The more than 10,000 funds in existence employ a variety of strategies other than long-short and would be unrecognizable as hedged funds by the esteemed Mr. Jones. Even so, the long view of hedge funds reveals a record that beats the performance of the S&P 500.

Looking back over the past twenty-years, S&P 500 annualized returns stand at 7.13%. In contrast, HFRI’s weighted composite of all hedge funds, regardless of strategy, delivered annualized returns of 8.84%. Equity hedge fund performance, viewed in the aggregate over the same period, demonstrates annualized returns of 10.3% … more than 3% ahead of the S&P 500.

Here’s the Point

Hedge fund managers do not rise from their nightly slumbers bent on the mission of beating the S&P 500 index. In fact, most who invest in hedge funds do not have beating the S&P 500 as their principal objective. All too frequently, the S&P 500 is the “go-to” index for those in the media struggling to understand hedge fund performance. While the S&P 500 is an important benchmark, it is not the yardstick by which most hedge fund investors gauge the performance of their chosen fund.

The quality of any hedge fund’s performance is best determined by its investors. Investors have a variety of goals and clearly defined expectations from their hedge fund investment. For example, many investors value the lower volatility that hedge funds provide. Others seek down-side protection and enhanced diversification, while still others view their hedge fund investment as a complement to their existing investment strategies. Obviously, none of these examples have strong ties to the S&P 500.

The bottom-line is that a variety of hedge funds, pursuing a plethora of strategies, cater to the diverse needs of investors. Rarely are those needs defined as outperforming the S&P 500.

 

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