The data below is taken only from investable indices - these must reflect real market conditions, and cannot afford to "drop" funds that do not perform well, since they are accountable to investors. We use the HFRX daily index, which is investable and covers a large universe of funds.
This graph shows the Total Return (including dividends) of the S&P500 index against the performance of the HFRX global daily hedge fund index. The timescale is since inception of the HFRX index. The stock market reached far higher than hedge funds, and then lost far more. It also shows that a direct comparison of hedge fund and stock market returns is not sensible - the stock market is far more highly geared.
In order to compare performance, we need to rescale the stock market returns - we can do this by gearing up the hedge fund returns with borrowed money, but this is very risky. Instead we de-gear the stock market returns by considering a portfolio combining some stocks, and some bonds.
This is a comparison of hedge funds against a portfolio of the S&P500 plus 5 year bonds (a very traditional investment portfolio), the portfolio is adjusted so that the high point of the hedge fund index in June 2007 matches the high point of the hedge fund index - this meant investing 30% in the S&P500, and 70% in 5 year bonds. The 5-year bond yield is taken from the start of the period (2.74% in March 2003). The hedge fund index is the HFRX global daily hedge fund index.
There are two surprising things about this graph.
- Hedge funds in aggregate very closely match traditional portfolios over this range. They seem to show almost no diversification benefit - when the stock market crashes, they crash too. They do not behave like a different asset class at all.
- Traditional portfolios outperformed hedge funds during the crash of 2008.
This is less surprising when you bear in mind the quantity of fees that hedge fund managers received over this period - assuming 2% of assets under managment over 5 years, and 20% of performance, which at it's peak was +36%, managers will have received fees totaling at least 18%.
It's worth noting that March 2003 was the end of the last bear market in stocks. A stock investment made in 2001 would show a far worse return - however 5-year bond yields were much higher at that time, so a 30% stock, 70% bond portfolio would have performed reasonably well.
Because I have chosen an investable hedge fund index, the fantastic yields of 1985-2003 were excluded from the hedge fund data. There is an argument that hedge funds had become more risky and less profitable did due to the large inflow of capital from 2003-2008. This seems to have been a factor in the quant funds crash of August 2007 (pdf), where market neutral "quant" equity funds suffered major losses. Also there is more discussion in this paper from GLC - one of the few fund managers whose funds didn't lose a penny in 2008.
Source of hedge fund index data: Hedge Fund Research, Inc., © 2009, www.hedgefundresearch.com
Source of S&P500 data: Standard & Poor's Index Services http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls
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