Are hedge fund clients reaping rewards?
In April, the New York City Employees' Retirement System decided to liquidate its allocation to hedge funds over concerns about performance. This move follows a similar decision by the California Public Employees' Retirement System, which stunned the investment community in 2014 when it eliminated its hedge fund program. CalPERS officials stated in a news release at the time that they made the decision to “reduce complexity and costs in its investment portfolio.” Turns out, the executives at CalPERS and NYCERS were right, and more importantly right for the right reasons.
Assets under management in hedge funds have skyrocketed from around $50 billion in 1993 to more than $2.8 trillion recently. Certainly, owners and managers of hedge funds are making money, and lots of it. The term billionaire hedge fund manager is now ubiquitous in news stories that range from Hamptons real estate transactions to financing political campaigns as illustration of the wealth they command.
But how have hedge funds performed for asset owners who are clients?
The academic community has wrestled for years with how best to assess and attribute returns generated by the growing army of hedge funds. The complexity in these funds' various methodological recipes pose a complicated analytical problem for academic researchers.
Offering the rigor necessary to properly address the question are Andrew W. Lo, the Charles E. and Susan T. Harris Professor at the Sloan School of Management, Massachusetts Institute of Technology, and chief investment officer, AlphaSimplex Group LLC; Mila Getmansky Sherman, associate professor of finance, Isenberg School of Management, University of Massachusetts; and Peter A. Lee, senior research scientist, AlphaSimplex. In their paper, “Hedge Funds: A Dynamic Industry in Transition,” published in the Annual Review of Financial Economics, December 2015, the authors' startling conclusion generated considerable media headlines at the time. The authors wrote: “The historical data show that hedge funds have not, on average, meaningfully outperformed traditional portfolios of stocks and bonds after fees.”
Their results should not have been surprising.