Report That Hedge Funds Outperform Stocks, Bonds and Commodities Too Rosy

Hedge funds outperformed stocks, bonds and commodities in the period from 1994 to 2011, according to a new report. The numbers, though, are a little too rosy.


A major report that received widespread coverage earlier this week painted a very upbeat picture of hedge fund performance. But it overlooked a number of key recent developments.

The 32-page report — part one of an eventual two-part tome published by KPMG and the Alternative Investment Management Association (AIMA) — found that hedge funds generated an average annual return of 9.07 percent from 1994 through 2011 after fees, compared to 7.18 percent for stocks, 6.25 percent for bonds and 7.27 percent for commodities.

An equal-weighted hedge fund index returned five times the initial investment after fees, over the 1994 to 2011 period.

The report also stressed the hedge fund performance was achieved with considerably lower volatility and Value-at-Risk (VaR) than stocks and commodities and close to bonds in both categories. The report also found that hedge funds were significant generators of alpha.

“We find that hedge funds provide economically important, risk-adjusted performance that provides investors with diversification benefits, even during the most difficult macroeconomic environment,” the report states. “We also show explicitly that the equal weighted portfolio policy in hedge funds, global stocks and bonds outperforms the conventional 60/40 allocation to stocks and bonds with significantly higher Sharpe ratio and lower tail risk.”


Sounds pretty impressive, huh? Well, as is usually the case, the data probably overstates the success and does not reflect how most investors in hedge funds are faring these days.

Even the report itself concedes that survivor bias usually plays an important role in the widely disseminated composite hedge fund data. After all, poorly performing funds frequently don’t disclose their results and those that do participate in surveys often stop sending off their data when performance turns south.

There are, however, other recent trends to consider besides survivor bias.

For example, last year the average hedge fund lost somewhere between 2 percent and 5 percent depending upon the database you consult. This was much worse than the major market indexes, when the Dow Industrials finished up 5.5 percent, the S&P 500 was flat and the Nasdaq Composite lost 1.8 percent.

What’s more, 2011 was the second year in the past four years the average hedge fund lost money. And remember, the hedge fund marketing machines have been touting their ability to generate positive absolute returns to explain why investors should no longer expect those 30 percent to 50 percent returns hedge fund investors became accustomed to in the 1990s.

And hedge fund investors also know that frequently the funds that do generate these outsized returns for a couple of years usually follow them up with a big fat double-digit decline.

Drilling further down, HFR also found that a majority of hedge funds — 55 percent — lost money in 2011. When the performance was broken down into ten equal numbers of groups of hedge funds, it found that just the top four performing groups of funds made money.

And only two of those four groups of hedge funds that made money beat the Dow, although all four outperformed the S&P 500, according to HFR. Still, only the top-decile group generated double-digit returns — posting on average a 19.51 percent gain.

And despite the overall market’s surge since March 2009 — and more recently since October 2011 — many hedge funds are still struggling. According to HFR, at the end of the first quarter, 61 percent of all hedge funds had reached their high water marks in the most recent 12-month period. This was down from 66 percent at year-end.

Meanwhile, a new survey published by Rothstein Kass found that 48 percent of 400 hedge fund managers representing 771 hedge fund vehicles warned that 2012 will be a difficult year, with nearly 40 percent worried about a double-dip recession.

And we learned in 2008 that many hedge funds have trouble navigating financial markets when the going gets especially tough.

So, be careful when you read those rosy hedge fund surveys.