So were hedge funds that bad in 2008?

By: ispeculatornew
Date posted: 01.16.2009 (4:00 am) | Write a Comment  (4 Comments)

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Today, we finally received the final numbers, the returns for the most known hedge fund index, the Credit Suisse/Tremont index that tracks over 5000 index funds. And the December returns came in basically flat as the index returned -0,03% which brings us to a total of -19,07% for the 2008 calendar year. Bad or not?

First off, just to clarify since hedge fund is such a large category, only 2 categories came out with positive returns in 2008. You will easily guess the first one:

Dedicated short bias 14,87%

Can you imagine that these funds almost disapeared in the past decade as consistent positive returns since 2001 have made life very difficult for funds that are “short” market. But investors that diversified here will be very happy with their returns.

The second category is:

Managed Futures 18,33%

These funds made solid profits from the very high volatility but also enjoyed numerous trends. Think about a fund that was long oil for a while and when the trend reversed set thgemselves short. That trade alone can make a year don’t you think?

But of couse, there are some less “solid” performances! And coming in last was Equity Market Neutral which is surprising given the fact that these funds should not be affected as much with declining markets like we saw in 2008. But irrational price movements during the year certainly hurt stock pickers…so here it goes:

Equity Market Neutral: -40,32%

Ouch! But in fact, the return is not that bad. Of course, like any investment, you have to compare. Let’s compare the total return of hedge funds, -19,07% to the return of the S&P 500, which was -38,49%! True, hedge funds did not return what they have promised for years, absolute returns (positive returns in each year no matter how the market reacts), but it did still outperform the general equity markets and in that sense, it’s easy to argue once more the power of diversification and investors that had diverisifiction across asset classes probably did much better in 2008 than others. Obviously, the best portfolio for 2008 would have been a cash portfolio or invested in government TBills, but few if any analysts would have predicted such a fate.

However, there is also another important part of the story that is the much documented and discussed Madoff fraud, which hurt the hedge fund index by creating some terrible returns (-100%) for some and highlighting a risk that has been underestimated by many hedge fund investors. Since these entities are subject to little regulation from regulators, due dilligence becomes very important and many investors have thus decided to withdraw funds from hedge funds even if returns were up to expectations.

Because of that, we expect many changes in the industry over the next few years in the financial markets, in how some products such as credit default swaps are traded but also in the regulations that hedge funds must comply with…

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4 Comments

  1. Comment by Praveen — January 16, 2009 @ 9:52 am

    The only thing to be wary about hedge fund indexes is survivorship bias.

    The Credit Suisse/Tremont Hedge Fund Index says:

    “In order to minimize survivorship bias, funds are not excluded until they liquidate or fail to meet the reporting requirements.”

    So, it minimizes it, but it is still there.

    In a market like we are experiencing, we don’t know how many hedge funds started off on the index, and then stopped reporting or liquidated.

    What if 8-10% of the funds on the index at the beginning of the year stop reporting, and they finished worse than 19.07%?

    So, a hedge fund investor, on average, could have experienced a worse return.

  2. Pingback by Hedge Funds - Mutual Funds For The Super Rich — January 19, 2009 @ 2:44 pm

    […] Intelligent Speculator Let’s compare the total return of hedge funds, -19,07% to the return of the S&P 500, which was -38,49%! […]

  3. Comment by the weakonomist — January 21, 2009 @ 9:48 pm

    The thing about hedge funds in 2008 is that we learned “hedge” means squat. 10x leveraged sub-prime loans are not hedging against anything. A hedge fund should be like insurance, works in the good and the bad.

    What we now think of as hedge funds should simply be ditch funds. The hedge fund brand is tainted, so now we need a new name.

  4. Comment by admin — January 22, 2009 @ 7:15 pm

    Hmm well yes, hedge funds are probably not the right name, that is how they started, but most categories I would do not pretend to hedge against anything. Long/short and market neutral funds would…but a emerging markets fund would generally be long only… not sure we need to change the name though?

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