Hedge funds, in aggregate, have generated positive alpha in the past 11 years. This finding, made by Roger Ibbotson, founder of Ibbotson Associates and Professor of Finance at Yale University, proves the strategies can resist powerful market declines but often fall short of providing absolute returns to investors. Investors should learn the ABCs – alphas, betas and costs – of hedge funds. SIMON MUMME reports.
“Hedge fund alpha was positive each year since the Asian crisis, even in 2008,” Ibbotson says, commenting on the updated figures in a research paper he is writing with Peng Chen, president of Ibbotson Associates, and Kevin Zhu, senior research consultant at the firm.Their finding comes as many hedge funds attempt to regain the trust of institutional investors, many of whom were dissatisfied with their performance in the financial crisis and their inability to redeem capital from some credit strategies, who imposed “gating” provisions to preserve their portfolios.
The final version of the paper, which is titled The ABCs of Hedge Funds: Alphas, Betas and Costs and will be released soon, analyses the returns of the 13,383 hedge funds within the TASS database between January 1995 to December 2009. It finds that the equally weighted return from the strategies – ranging from convertible arbitrage, equity market neutral and managed futures – was 7.63 per cent, after fees, for the 15-year period. Of this, 3.01 per cent is attributable to manager alpha, and 4.62 per cent to market beta in the form of stocks, bonds and cash.
For Ibbotson, Cheng and Zhu, market beta includes non-traditional betas, such as momentum and derivative-based factors. Their justification for this is such non-traditional betas are not as readily available to investors as stocks, bonds and cash instruments, and that hedge funds are a primary means of accessing the other betas.
Among the hedge fund strategies, long/short equity generated the most alpha, serving up an annual 5.16 per cent, followed by emerging strategies with an annual 5 per cent, then event-driven funds with an annual 3.73 per cent. Shorting strategies and managed futures produced the least alpha, delivering 1.74 per cent and 1.17 per cent annually.
But as investors know, hedge fund alpha does not come cheaply. Assuming the managers charge a 1.5 per cent management fee and 20 per cent performance fee, the researchers calculate an average alpha/fee ratio of 0.8. This means the alpha recieved by investors is equivalent to 80 per cent of the fees they have paid to managers.
