ARE HEDGE FUNDS A SUITABLE BOND SUBSTITUTE?
Our analysis show growing hedge funds quotas in investment strategy portfolios. After hedge funds could not prove their “all-weather suitability” during the 2008 financial crisis they came under pressure and investors were losing their interest. However, recently we observe a renaissance. The record-low interest rates are forcing investors to consider alternatives to bonds. The question arises whether hedge funds are suitable for the job.
Reference index data does not show reality
Performance data from hedge funds has to be analysed with caution, since they are not required to publish their data. Reference indexes are mostly fed by successful hedge funds. Closed funds fall out of the data series. The resulting index data shows significantly overvalued returns versus the effective returns of the whole hedge funds universe. This effect is called survivorship-bias.
Historical estimates suggest that hedge funds have been able to achieve returns that are well above an average of bond and stock market in the past. So despite the “bias-effects”, they were quite attractive. However, recent studies show that hedge funds’ returns were consistently lower between 2009 and 2016.
Our own analysis confirm these observations. Returns on a portfolio consisting of 45 % equities, 45 % bonds and 10 % cash have fallen from 7.36 % (in USD) between 1998 and 2007 to 4.25 % p.a. between 2007 and 2016 – mainly due to the deflationary environment and the low interest rate policy. By contrast, the average annual returns of hedge funds went back from an above average 9.96 % to a below average -0.08 % p.a. in the two comparative periods.
The lower performance of Hedge funds can only partially be explained by lower market returns, e.g. by the lack of interest on collaterals, in recent years. The steady upswing in the financial market, stimulated by the national banks, has resulted in reduced market volatility and increased correlation between and within almost all investment categories. This environment was detrimental to most Hedge funds strategies.