This Study Proves Hedge Fund Performance Has Worsened In Recent Years

There have been numerous news articles claiming that hedge fund performance has deteriorated over the previous 10 to 15 years, but now a new study backs up those claims. Between 1997 and 2016, Nicolas P.B. Bollen, Juha Joenvaara, and Mikko Kauppila examined hedge fund performance in comparison to other asset classes. Following the Global Financial Crisis, hedge funds began to lag behind a standard stock and bond portfolio from 2008 to 2016.
On an electronic display, stock market moves are shown. (C) 2021 Bloomberg Finance LP/Paul Hanna/Bloomberg/Paul Hanna/Bloomberg/Bloomberg/Bloomberg/Bloomberg/Bloomberg/Bloomberg

Bollen and his team looked at six commercial databases of returns during the two eras to assess hedge fund performance. During the first 10 years, they discovered that their equally weighted hedge fund index had a cumulative return of 225 percent, greatly outperforming an equally weighted stock and bond portfolio, which had a cumulative return of 125 percent.
Despite the sharp decline in the equity markets during the financial crisis, the hedge fund portfolio recovered only 25% between 2008 and 2016, while the stock and bond portfolio returned 70%. With good Fung and Hsieh alpha, Bollen and his team discovered a large drop in money.
Between 1997 and 2007, 20% of hedge funds generated positive, meaningful alpha, but that ratio plummeted to 10% during the second timeframe. Furthermore, the percentage of people with highly negative alpha increased from about 5% to around 20%.
Bollen explained why they used several hedge fund indexes to estimate hedge fund performance throughout the two eras in an email interview. He claims that returns are skewed to the positive since hedge funds with poor performance are less likely to report to an index.
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“It has been shown that relying on only one of the commercial databases biases aggregate hedge fund performance higher,” Bollen argues, “since funds with superior performance report to all databases, whereas funds with bad performance report to only one.”
“As a result, funds that performed well will be over-represented in any particular database sample. As a result, before evaluating industry performance, we must consult the aggregated database.”
The accommodating monetary policy is one of the reasons hedge funds have struggled to perform over the last 12 years. Hedge funds have faced a huge difficulty as a result of the substantial sums of stimulus provided over the last year.
“As we show in the article, the US Federal Reserve’s quantitative easing is linked to higher correlations between individual equities, stock indexes, and hedge funds,” Bollen said. “Security selection and long/short strategies are more difficult to execute when correlations are strong than when correlations are low. Furthermore, the flood of money has purposely lowered yields across the board, resulting in potentially bloated equity values. As a result, passive stock and bond investments have outperformed the market and are difficult to beat.”
Despite the fact that hedge fund performance has dipped in recent years, Bollen believes they still have a place in investor portfolios.
“We still find that the Fung-Hsieh seven-factor benchmark’s alpha and Bali, Brown, and Caglayan (2014)’s macro timing measure are useful in selecting a collection of funds that provide a diversification benefit,” Bollen noted. “Our tests are based on net-of-fee returns, demonstrating that an allocation to hedge funds might provide investors with lower overall portfolio volatility even after fees are factored in. However, from 2008 onwards, the expense of obtaining this diversification benefit has taken a toll on average returns. This suggests that only those investors with a high level of risk aversion will find the risk-return tradeoff attractive.”
Bollen does not anticipate hedge funds will go away because of the diversification benefits they bring. He pointed out that the industry’s assets under management have reached new highs, and he doesn’t believe passive funds will always outperform actively managed hedge funds.
“With bond yields near historic lows and equities values near historic highs, it is unlikely that passive investments will be able to generate the same returns as they did in the past,” he added. “Institutional investors with lower stock and bond market return projections will likely find it more advantageous to continue to allocate to alternatives such as hedge funds, private equity, and real assets.”
Bollen also has some recommendations for individuals looking to add hedge funds to their portfolios.
“Past alpha appears to be one of the best predictors of performance,” he said. “More broadly, we believe that a manager’s long-term track record and demonstrated capacity to absorb shocks like the ones we saw last spring should be top-of-mind for investors when choosing funds.”/nRead More