Has the time come for institutional investors to abandon hedge funds?
Over the last five years, hedge fund indices have underperformed global equities by 8% pa. Active managers in general have been struggling, whilst “passive” alpha-seeking strategies such as smart beta have been gaining ground.
Investors are asking increasingly difficult questions about hedge funds. Some are focusing on the extravagant level of hedge fund fees, whilst others are suggesting that persistent alpha is impossibly elusive. And there’s even controversy over the actual level of historic hedge fund returns – after allowing for survivorship and backfill bias.
Below, we compile the best white papers on the subject, so that you can make up your own mind.
Is the Hedge Fund Heyday Behind Us? (Cambridge Associates, 2016)
Cambridge Associates takes a step back from recent travails and assesses the outcome of hedge fund investment across market cycles over the last fifteen years, examining the extent to which hedge funds have contributed to the alpha component of returns.
Hedge Funds: A Dynamic Industry in Transition (Lo, Getmansky and Lee, 2015)
In this paper, Andrew Lo, Mila Getmansky and Peter Lee argue that survivorship and backfill bias halve apparent hedge fund returns. They analyse the latest hedge funds research, including the latest empirical evidence for the industry.
Relax, Hedge Funds Do Just as Well as You Thought (2015)
Written in direct response to the paper above, Eqira’s Will Williams, CFA argues that Lo, Getmansky and Lee overstate the impact of backfill and survivorship bias. He supports his claim by using historical returns for fund of funds and endowments, both of which are less affected by biases.
Hedge Fund Returns – survivorship bias and future return forecasts
For a simple introduction to survivorship and backfill bias, and a discussion of future hedge fund returns, try this Savvy blog post, which explains the concepts simply.
Hedge funds in strategic asset allocation (Lyxor, 2015)
This 60-page white paper looks at hedge funds in the context of Strategic Asset Allocation and develops a recommended process for incorporating hedge funds into a multi-asset portfolio. The process examines hedge funds in terms of their exposure to common risk factors, and also examines biases in HF databases, tail risk, non-normal distributions and performance persistence.
An Analysis of U.S. Public Pension Investments in Hedge Funds (2015)
Hedge funds argue that they provide volatility reduction and absolute return. This report, a collaboration between the American Federation of Teachers and the Roosevelt Institute, analyses whether this has, in fact, been the case.
Hedge Fund returns - a new era? (Lyxor, 2015)
The authors evaluate the drivers of HF returns and conclude a period of hedge fund outperformance is on the way. Hedge fund annual excess returns are forecast of around 5-6% pa.
A Practical Look at Enterprise Risk Analysis and Alternative Investments (BNY Mellon, 2016)
This paper from BNY Mellon examines how can institutional investors can apply enterprise risk analysis (e.g. scenario analysis and stress testing) in assessing hedge funds and other alternative investments.
Other Recent Hedge Fund Papers
Top 10 Hedge Fund Industry Trends for 2016 (Agecroft Partners, 2016)
Agecroft Partners are well placed to predict the top HF industry trends, given their associations with over 2,000 institutional investors and hundreds of hedge funds. This paper seeks to help investors and businesses to benefit by anticipating - and preparing for - the likely changes.
Hedge Fund Investing: Manager Selection and Due Diligence (Merrill Lynch, 2015)
Hedge fund manager returns are widely dispersed, and this paper from Merrill Lynch aims to show investors how tangible alpha can be gained through careful due diligence and skilful manager selection.
Chasing Hedge Fund Winners: The Appeal and the Risk (Commonfund, 2015)
In this 9-page report, Commonfund argues that buying into high-performing hedge funds, although it appears to be an effective strategy, is less effective at longer time intervals. In most long-term evaluation windows, "winning" portfolios are often outperformed by "losers."
Global Hedge Fund Distribution Survey 2015 (PwC/AIMA, Dec 2015)
This 30 page report analyses the disruptive forces currently impacting HF distribution, and examines how HF businesses are responding. The paper has a particular focus on which products are selling, the landscape for liquid alts, and the impact of regulation.
Hedge fund financing challenges under Basel III and beyond (AIMA/S3 Partners)
This report seeks to cut through the noise and explain how Basel III and associated regulations have impacted HF managers to date. It also examines how the hedge fund / prime broker relationship might change in future years.
Hedge Fund Replication and Alternative Beta – an overview
If you are interested in how hedge fund returns can be systematically replicated at lower cost, then read this Savvy blog post which summarises the best papers on the topic.
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