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- “Alpha” has been declining over time and across hedge fund subcategories — much as it has in the long-only fund space.
- Top-quartile performance remains worth pursuing, but can be difficult for hedge fund allocators to capture consistently over time.
- In today’s challenging hedge fund landscape, the largest, most experienced, well-resourced hedge fund managers look best positioned to reliably deliver alpha.
HEDGE FUNDS CAN PLAY AN IMPORTANT ROLE IN INSTITUTIONAL INVESTOR PORTFOLIOS. For example, investors may allocate to such funds for return enhancement potential, efficiency benefits, and/or portfolio diversification. In recent years, however, persistent frustrations with hedge fund performance have led many investors to question the effectiveness and justification of this type of allocation.
To address such concerns, we conducted a comprehensive study of equity hedge fund characteristics and performance going back to the 1990s. We modeled hedge fund returns within a factor framework using “cleaned”1 HFR2 data on the “Equity Hedge” universe and a number of its subcomponents3:
- Equity Market Neutral
- Fundamental Growth
- Fundamental Value
- Quantitative Directional
We believe the conclusions reached from the study may help hedge fund investors: 1) better understand the historical (and perhaps future) drivers of equity hedge fund performance; 2) pinpoint the specific fund traits to look for in pursuit of more attractive equity hedge fund returns; and 3) ultimately improve their construction of long-term hedge fund allocations.
Although the scope of our study was deliberately limited to equity hedge fund performance, it is worth noting that the systematic methodology and analytical framework we have developed may be applicable to other asset classes and…
1Please see “Appendix: Dataset and Methodology” for a full explanation. | 2HFR = Hedge Fund Research | 3Single-manager hedge funds are classified into strategies and substrategies according to the HFR Strategy Classification. The major strategy classifications are: “Equity Hedge”; “Event-Driven”; “Macro”; and “Relative Value.” Within the “Equity Hedge” category universe, the substrategy classifications are: “Equity Market Neutral”; “Fundamental Growth”; “Fundamental Value”; “Quantitative Directional”; “Sector”; “Short Bias”; and “Multi-Strategy.”