Cause for celebration if you’re a hedge fund manager, right?
According to a Bloomberg report, the average hedge fund in Eurekahedge’s index was up 5.2% in May, the best single monthly performance in nine years.
Here is a table of the monthly changes in the Eurekahedge hedge fund index since the beginning of last year, with the return on a global equity benchmark, the iShares MSCI World Index ETF (LSE: IWRD.L) shown for purposes of comparison.
| Month Ending | Eurekahedge Hedge Fund Index (%) | iShares MSCI World ETF (%) |
| Jan-08 | -2.09 | -7.38 |
| Feb-08 | 2.53 | -0.99 |
| Mar-08 | -1.87 | -0.61 |
| Apr-08 | 1.31 | 4.40 |
| May-08 | 1.78 | 0.63 |
| Jun-08 | -0.57 | -7.95 |
| Jul-08 | -2.01 | -2.21 |
| Aug-08 | -1.28 | -2.09 |
| Sep-08 | -4.52 | -11.17 |
| Oct-08 | -4.82 | -18.56 |
| Nov-08 | -1.19 | -7.08 |
| Dec-08 | 0.77 | 3.25 |
| Jan-09 | 0.32 | -9.08 |
| Feb-09 | -0.88 | -10.84 |
| Mar-09 | 1.40 | 7.60 |
| Apr-09 | 3.01 | 11.17 |
| May-09 | 5.72 | 8.17 |
Notice anything interesting? Eleven of the last 17 months have shown a negative return for the MSCI World tracker. In nine out of those eleven months, the hedge fund index gave a negative return too. Now that global equities have given us three months of healthy positive returns in a row – surprise, surprise – so has the hedge fund index.
I remember Jim Rogers saying that a previous boom in hedge funds, in the late 1960s and early 1970s, came to an end when the 1973/74 bear market revealed that a lot of the funds were in fact much more geared to equities’ performance than they had claimed.
For all their talk of Sharpe ratios, correlations, alphas and betas, has it been any different this time?
A glance at the respective columns for the monthly returns of hedge funds and the MSCI World ETF and a wholly unscientific, back-of-the-envelope calculation suggests to me that, if you had wanted to replicate the Eurekahedge index’s performance, you could have stuck 25% of your assets in the MSCI world ETF and the remaining 75% in a short-maturity bond ETF. This would arrive at essentially the same results (except that you’d be paying 20-30 basis points in fees for your ETFs, rather than “two and twenty”).
If I then look at what the IndexIQ Hedge Fund ETF (NYSE Arca: QAI), which aims to replicate hedge funds’ performance, albeit with a 1.1% annual fee, actually holds, then I find about 15% in emerging market equity ETFs (in other words, a geared version of a global equity benchmark) and the rest in a variety of bonds! QAI also held positions in commodities (1%), inverse funds (1%) and real estate (2%) at the time of the factsheet’s publication, but these are very marginal. Matt Hougan did the same analysis on IU.com a few months ago, with similar results.
I also know, from a previous job, that when we looked at the combined performance of six supposed “absolute return” (i.e. hedge fund) portfolios run within the company, we found that, in aggregate, they behaved like a low-volatility mixture of equities and bonds. In other words, there was a clear (but low-beta) correlation to the performance of shares in aggregate. The performance of Eurekahedge’s hedge fund index over the last few months is evidence of the same thing. I see that Fintag has (very honestly) reached the same conclusion, though he’s not too happy about it.
What does this all mean? In my view, it all adds up to a resounding vote for ETFs. Ditch hedge funds, ditch hedge fund replicators, and invest in the cheapest possible equity and bond trackers. And never underestimate the ability of those clever marketers from the fund management industry to dress mutton up as lamb, or should I say beta as alpha.
