What good are hedge funds?

How can they beat the market consistently, especially if we take EMH seriously at all?  And if they don’t beat the market, how is 2-20 to be justified?  Here is a snippet from an interesting Amazon review:

…this kind of comparison misses the entire point of most hedge funds. A market-neutral fund is not designed as a stand-alone investment, but as a diversifier for an equity portfolio. It can have half the return of equities with the same volatility, and still be valuable. The question isn’t whether putting 100% of your money in hedge funds did better than putting 100% in stocks, it’s what portion of assets an investor should allocate to hedge funds. Using the author’s own numbers, an investor would have done best to have 30% of assets in hedge funds, rebalancing annually, from 1998 to 2010. That produced 4.2% annual alpha (return in excess of what you could have gotten investing in stock index funds and t-bills with the same volatility). That number is certainly overstated, hedge fund investors typically do worse than the index suggests, but it demonstrates that you can’t consider only stand-alone returns. This point is borne out by the finding that endowments and pension funds that make use of hedge funds have consistently better risk-adjusted performance than those that do not.

The review, by Aaron C. Brown, offers other points of interest.  I’ve ordered the underlying asset itself (the book) and I will report back on it.  It was reviewed in today’s FT, still no permalink.

Here is a recent story on hedge fund closures.


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