I’m not saying anything innovative when I say that finance is very very competitive and that is one of the reasons why every competitive edge is used when selling products. And for investments, that is obviously return. But in a world where returns can vary from +20% to a year like 2008 where even getting -20% can be considered “good”, it is difficult to compare returns and for that reason, investors have been comparing their returns to the returns of the market for about a century now. Of course, since there is no perfect “market”, many dozens of indexes exist depending on what you are comparing with.

Generally speaking, returns have been compared with stock indexes such as the S&P 500, a broad US stock market index that covers the 500 largest US corporations traded on stock exchanges (more or less). And so for decades, investors have been trying to outperform these indexes through a multitude of ways. Then hedge funds came along, saying they were unique and that they could deliver absolute returns. An absolute return in theory would mean that no matter how good the year, your investment would generate a positive return and thus not really apply to a given index.

That became a major selling point and of course over the past couple of years, many investors have discovered the tough way that absolute return is maybe not as easy to obtain as it looks. Many funds have performed poorly in 2008 and in fact the average hedge fund track by Credit Suisse Tremond returned about -20%! Better than the market? Yes, but surely not what they were selling.

So now, hedge fund managers are selling the fact that their returns performed better than the overall market. Might be true. But I’m having a hard time applying this to my personal situation. As you know by now, the picks on IntelligentSpeculator are generally long/short. The advantage of course is that I’m not as affected by huge market moves since I do not have much of net market exposure, I’m long and short. So on a major down day like we had last week, I will outperform the market generally (if the spread between my picks remains the same), and the opposite will happen on good days.

That has made me think about the validity of comparing my picks to the S&P500 when in fact they are really absolute picks. I’m tending to convert back to simply getting an absolute return and comparing that return to similar fund returns instead. And so this draws me to a question: While not hedge funds are in this situation (especially short bias funds or other funds that do have a general market direction), would you agree that hedge funds that are long-short should be evaluated using an absolute return. It might not be over 0%, but if that is the case, either it is a bad year, or a bad manager. But comparing to a broad market index simply seems like a misrepresentation of results….

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