Practical analysis for investment professionals
06 December 2012

Current Thinking on Hedge Funds: Are They Worth It?

Amid a growing list of disasters, many are increasingly questioning the claims of hedge funds to offer absolute returns. In one corner is Simon Lack’s critique, which he lays out in his book, The Hedge Fund Mirage, and recently summarized at a recent CFA Institute conference. Lack argues that the hedge fund industry is guilty of misrepresenting their claims of performance. In another corner, new studies and approaches seem to support the performance claims of hedge funds, particularly the very largest and smallest.

It is undeniable that numerous frauds and blowups, unpopular restrictions on investor withdrawals, exorbitant fees, and embarrassingly weak performance have left former enthusiasts unimpressed. But in their place institutional portfolio managers seeking volatility-cutting alternatives to pricey bonds and unrewarding cash have made significant allocations to hedge funds, hoping for relative if not absolute returns.

In search of enlightenment, our team of CFA Digest abstractors evaluated recent research about hedge funds and alternative strategies for hedging.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/JLGutierrez

About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, is director of publications at CFA Institute, where he contributes to a suite of publications that includes the Financial Analysts Journal, CFA Digest, and Conference Proceedings Quarterly. He has more than 12 years of investment experience as a portfolio manager and securities analyst. As investment manager of the West Midlands Pension Fund, part of the UK local government pension fund, Harrison managed a portfolio of European equities and had oversight of external managers and hedge fund selection. He is also the author of The Empowered Investor and holds the ASIP designation. Harrison holds BA and MA degrees from the University of Oxford.

3 thoughts on “Current Thinking on Hedge Funds: Are They Worth It?”

  1. Roy Connelly says:

    This is absolutely informative! Thanks for sharing more ideas on hedge funds!

  2. Thank you for posting these resources.

    On Opalesque.TV, the two poles regarding hedge funds span from Simon Lack (“T-Bills better than hedge funds?” – http://www.opalesque.tv/hedge-fund-videos/simon-lack/1) and Alexander Ineichen (” Why the investment case for hedge funds is still sound”: http://www.opalesque.tv/hedge-fund-videos/alexander-ineichen/1).

    “We were better when we were smaller”, says Lack in a video interview on Opalesque.tv He agrees that there are “great hedge funds out there”, that some of the most talented investors in history run hedge funds, and that plenty of investors are happy with their hedge fund investments.

    However, in his analysis, Lack is not looking at individual funds, but at the total dollar amount put into hedge funds by investors. The profitable years of the late 90s involved far fewer investors than today, and after hedge fund assets started to balloon from 2000 onwards, investors would be missing out: Looking at the aggregate investor profits and fees from 1998 to 2011, Lack estimates that 84% of the total went as fees to the hedge fund managers, 14% to fund of funds and just 2% went to investors as investment returns.

    Ineichen, on the other hand, says that “while hedge funds have not shot the lights out, they have largely outperformed global equities and balanced portfolios (5yr rolling) and that from a qualitative perspective, the investment case for hedge funds is still sound.”

    He also pointed out that average hedge funds surviving 2008 reached their high-water already in Sept. 2010, while financials might need until 2024, assuming 6% annual growth. Hedge funds would be the only sector of asset management offering active risk management…

    http://www.opalesque.tv/hedge-fund-videos/alexander-ineichen/1 – enjoy!

  3. Hicks says:

    It’s essential to read the hedge fund research especially the papers estimating the massive survivorship bias from funds that were either closed or never submitted into hedge fund indices. A remarkably clear picture arises : many hedge funds are conservatively run and produce indifferent returns; the vast majority of high performing funds take on massive additional risk – leverage, lack of liquidity in underling investments, lack of diversification. In practice you will find that most hedge funds generate minimum alpha and that it is hard to identify in advance those few that will perform. Consultants and trustees will however continue to pour money into hedge funds- after all anything is better than stopping the gravy train for advisers and forcing institutions to recognise that pension funds are underfunded. In the meantime as Lack points out the major winner will be hedge fund managers.

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