Hedge fund managers don't appear to have persistent investment skill.
The conclusions of a new study that compared U.S. offshore hedge fund performance to selected style benchmarks don't make a compelling case for hedge fund investment, said Roger Ibbotson, one of the three co-authors. Mr. Ibbotson is president of Ibbotson Associates, Chicago, and a professor at Yale University, New Haven, Conn.
Even among global macrostyle funds, which include funds managed by high-profile hedge managers like George Soros, "there's no evidence of (hedge funds) having positive alphas relative to their special benchmarks," Mr. Ibbotson said.
Nonetheless, Mr. Ibbotson said the study shouldn't discourage investors who already view hedge funds favorably from investing with them, because of the limited amount of quantitative data available to the study's authors.
Hedge funds are private investment partnerships that can offer a variety of investment styles, and often can use leverage and short selling. The offshore version generally is not designed for U.S. investors.
Their fees generally are much higher than traditional money managers. Typically they'll charge 100 or 200 basis points, plus keep 20% of the returns.
Hedge fund use by institutional investors, mostly endowment funds, has been on the upswing in recent years. The funds are viewed by proponents as a means to provide good returns that are not strongly correlated to the stock and bond markets.
Responding to the study, consultants and money managers in the hedge fund industry contend numbers alone don't tell the story of what makes a good hedge fund manager.
The qualities that make a good hedge fund manager won't necessarily show up in performance attribution, they say .
"Clearly, I disagree" with the study's results, said Paul McKean, executive vice president with Naples, Fla.-based LJH Alternative Investment Advisors, which has advised on the placement of more than $1 billion into hedge funds as a consultant and a manager of managers.
The study's lack of data points - it relied on annual returns - makes the results suspect, he said.
"Doing any kind of quantitative analysis (of hedge funds) is a very dicey game," Mr. McKean said. "The qualitative aspects of analyzing (hedge fund) manager returns are much more important."
"You can prove manager skill," but it won't necessarily show up in the techniques used by the study's authors, said E. Lee Hennessee, who heads hedge fund consultant Hennessee Group L.L.C., New York.
Making returns-based conclusions about hedge fund managers doesn't make sense, she said, referring to the study's grouping of managers using statistical returns analysis techniques.
Mr. Ibbotson acknowledged the conclusions are not definitive, but he said the professors worked with what they thought was the best available data.
Mr. Ibbotson and his co-authors, William N. Goetzmann, also a professor at Yale, and Stephen J. Brown a professor at New York University's Stern School of Business, patterned the study after a similar mutual fund study that asked the question: "Do winners repeat?"
Using returns-based statistical techniques, they grouped the offshore hedge funds listed in the U.S. Offshore Funds Directory, published by Antoine Bernheim, into nine categories of managers.
Within those categories, the professors tested to see if strong performing managers repeated that success. The answer was no. They looked at successful managers relative to both the median manager in the group, and to statistically chosen benchmarks.
Mr. McKean said the study's assumption that hedge fund managers drop out of databases purely because of bad performance is not appropriate.
As an example, he cited press reports indicating Long Term Capital Management, a Greenwich, Conn.-based hedge fund manager, is giving back half of its assets because it has gotten too big.
"If you look in a lot of databases, you're not going to find Long Term Capital Management," even
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though they have been successful, he said.
Ms. Hennessee said offshore investors are much more fickle than U.S. hedge fund investors, so more funds will have been shut down, even if a manager's style is successful longer term.
"One or two quarters of bad performance, and they're gone," she said in regard to offshore fund investors.
Mr. Ibbotson acknowledged there might be managers who dropped out of databases for reasons other than bad performance, but those are likely to be exceptions. In 1995, the last year looked at in the study, 33 hedge fund managers went defunct, four were removed by the publisher, and 21 were dropped at their request.
Others underscored the importance of qualitative analysis in selecting hedge fund managers, but were less critical of the study and its results.
Jim Berens is director of research for Collins Group, Newport Beach, Calif., which invests in hedge funds on behalf of institutions. He noted the study results do show a positive alpha for hedge fund managers over the term of the study.
It is only the persistence of that alpha the study cannot find.
"We've reached somewhat similar conclusions," he said.
He agrees with the study's basic conclusion: that there is alpha among hedge fund managers, but using past performance to pick a hedge fund manager is probably a bad idea.
Collins Associates executives analyze the investment processes of hedge fund managers, and try to see if it is repeatable, he said. They also try to see if the hedge fund manager can succeed as an investment organization, he said.
And in Collins' direct experience investing with hedge funds, they have found alpha, he said.
Patrick J. Moriarty, who works with hedge funds for Evaluation Associates Capital Markets Inc., Norwalk, Conn., said: "We do a lot of quantitative (work), but in the end we think qualitative is more important."
"Performance is really the last thing we look at," Mr. Moriarty said.
Some other consultants said the study's data source wasn't a proper sample of the hedge fund industry.
Joseph Nicholas, president of Hedge Fund Research L.L.C., Chicago, said: "The study is hugely flawed, and is not representative of the hedge fund world." By example, he noted that in the 1994 data the study used, only about 56% of the funds in the book were actually hedge funds.
