23 April 2012

KPMG/AIMA Report: 'The value of the hedge fund industry'

This report, presented by KPMG and the Alternative Investment Management Association (AIMA), examines and summarises the value provided by the hedge fund industry to investors, to markets, and to the broader economy.

The analysis is divided into two parts: a quantitative analysis of hedge fund performance and a literature review.

The Centre for Hedge Fund Research at Imperial College London has created a unique aggregate hedge fund and benchmark index database. The database represents a careful aggregation of all the current information from multiple leading sources about hedge fund performance globally. Survivorship bias is not a factor because both active and inactive funds are included. Using HFR (Hedge Fund Research) hedge fund index data from 1994 to 2011, performance analysis shows that hedge funds have significantly outperformed equities, bonds and commodities on a risk adjusted basis. The research found that hedge funds achieved an average return of 9.07 per cent in the period 1994–2011 after fees compared to 7.18 per cent for stocks, 6.25 per cent for bonds and 7.27 per cent for commodities. Hedge funds achieved these returns with considerably lower volatility and Value-at-Risk (VaR) than stocks and commodities, close to bonds in both categories. The research also demonstrated that hedge funds were significant generators of “alpha”, creating an average of 4.19 per cent per year from 1994–2011.

An equal-weighted hedge fund index returned five times the initial investment after fees, over the period 1994–2011. The report finds that hedge funds provide economically important, risk-adjusted performance that provides investors with diversification benefits, even during the most difficult macroeconomic environment. It also shows explicitly that the equal weighted portfolio policy in hedge funds, global stocks, and bonds outperforms the conventional 60/40 allocation to stocks and bonds with significantly higher Sharpe ratio and lower tail risk. Specifically, the report shows that an institutional investor, who adds hedge funds to the conventional 60/40 portfolio policy, can gain economically important benefits of diversification. The research also finds that investors received approximately 72 per cent of all investment profits over this period, compared to 28 per cent for hedge fund managers. Importantly, hedge funds’ ability to generate superior performance is not associated with significant risk-taking as measured by volatility or Value-at-Risk. Indeed, the report documents that hedge fund volatility is reasonably low across investment strategies, compared to conventional asset classes.

The study finds that correlations between hedge funds and main asset classes are only slightly higher during recessions, suggesting that hedge funds are unlikely to threaten the stability of the financial system.

The review of the literature on the value of the industry to investors, to markets, and to the broader economy shows that hedge funds are important liquidity providers in the markets that they are active in.

Moreover, hedge fund activity has beneficial effects for price discovery, the efficient allocation of capital, financial stability, shareholder value, diversification and the broader economy.

Full study

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