Do hedge funds actually beat the market?

So hedge funds is supposedly a vague term, right, referring to entities that invest via like trading systems and things like that.

How does the industry do on average? Does anyone have this information?

Cause my first thought is they probably just meet basic market returns on average (... see Efficient Market Hypothesis ...) but i'd be interested to hear what other people have to say.

Comments (52)

8y 
notthehospitalER, what's your opinion? Comment below:

There is lots of research saying a bunch of stuff, most point to the research that says hfs underperform the market. Some beat consistently, lots don't

8y 
thebrofessor, what's your opinion? Comment below:

here's the deal, all of these money managers, PWM guys, HF guys, AM firms, traders, they are all "the market." if you take the returns of every money manager out there, they will on average be market returns minus fees because they are the market. therefore, it is impossible for everyone to beat the market, and I would argue that simply because there are so many hedge funds out there, it's impossible for everyone in one area (convertible arb, long short, etc.) to outperform their benchmark because they are what comprises their benchmark.

now, if your question is do they outperform an unrelated thing like stocks vs. bonds, hedgies vs. inflation, that's a different argument entirely, but to answer your question directly, hedge funds is way too broad to give you an accurate answer and no, it's impossible for everyone to beat the market all the time. but also EMH is stupid.

learn more about the industry, there's all kinds of subsets of HF and their goal may not even be to beat the S&P 500. for example, merger arb is designed to capture an inefficiency in the market and it's essentially a spread product that ends up having mid single digit returns with extremely low vol over long time periods. you'll never get Buffett like returns there but that's not their goal. it wouldn't be fair to compare them with mohnish pabrai who holds 10 stocks and likely has very high vol but great returns, it's like comparing apples to razorblades.

8y 
handullz, what's your opinion? Comment below:
thebrofessor:

here's the deal, all of these money managers, PWM guys, HF guys, AM firms, traders, they are all "the market." if you take the returns of every money manager out there, they will on average be market returns minus fees because they are the market. therefore, it is impossible for everyone to beat the market, and I would argue that simply because there are so many hedge funds out there, it's impossible for everyone in one area (convertible arb, long short, etc.) to outperform their benchmark because they are what comprises their benchmark.

now, if your question is do they outperform an unrelated thing like stocks vs. bonds, hedgies vs. inflation, that's a different argument entirely, but to answer your question directly, hedge funds is way too broad to give you an accurate answer and no, it's impossible for everyone to beat the market all the time. but also EMH is stupid.

learn more about the industry, there's all kinds of subsets of HF and their goal may not even be to beat the S&P 500. for example, merger arb is designed to capture an inefficiency in the market and it's essentially a spread product that ends up having mid single digit returns with extremely low vol over long time periods. you'll never get Buffett like returns there but that's not their goal. it wouldn't be fair to compare them with mohnish pabrai who holds 10 stocks and likely has very high vol but great returns, it's like comparing apples to razorblades.

great post... question though.

if there are some merger arbitrage HFs out there... designed to decrease volatility..

why dont most people w/ portfolios just throw some bonds in there? instead of dealing w/ the fees and threat of losing their money and the HF closing shop?

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8y 
thebrofessor, what's your opinion? Comment below:

ehhh you're comparing apples to oranges and misunderstanding what merger arb is. in the plainest form, a company buys the stock of a company that's to be acquired AFTER the announcement, and captures the spread (not risky such that a fund could blow up pretty easily). this is after the company's done the due dili and has a high degree of confidence the merger goes through. Let's use a real life example of a stock I owned and sold this year, COV:

announcement was made back in June that MDT was buying them for $93.22, I got out at $87.27, or roughly a 6.8% discount to the merger price. since the announcement, the stock has been between 82 and 94 which I'd argue is more a function of heightened volatility than the underlying deal (although now with the tax inversion stuff, this deal is coming under fire). absent all of that, this is a common occurrence and works pretty much like clockwork, a target's stock will rise to a mid-single digit % discount to the final price. go back to historical mergers, look at the price action from the day of the announcement to until the deal completes.

why does this difference exist? this spread is essentially the risk that the deal falls through as well as the opportunity cost of holding cash/short term bonds while the deal is closed. so yes, while this spread is deal-dependent, it also depends on the general level of interest rates. if rates are low, spreads will be low and vice versa, but the difference is an uptick in rates helps merger arb funds whereas widening spreads hurt bonds (theoretically).

if you're talking about mergers that are guesses so you short an acquirer and buy the hypothetical target on leverage, yes that's a great way to get blown up and is a poor bond surrogate, but that's more dependent on manager skill and luck than what I'm talking about. what I'm talking about has low vol long term (and lower returns than this example) and is a persistent characteristic of markets.

capiche?

PS: as to your question about fees, you still pay fees to buy bonds (how do you think dealers make money?), and I'd be surprised to see a 2/20 structure on a merger arb fund, that's more of a long/short or global macro thing, but I'm not a hedgie so I could be way off here.

onto your question about merger arb v. bonds, the two are completely different. bonds are built for income & stability and capturing a reasonably well guaranteed return regardless of what equity markets do. merger arb is designed to capture a persistent inefficiency with markets and to take advantage of widening spreads, but often provides little to no income. we could argue it all day but I think both asset classes have their merit and aren't mutually exclusive.

8y 
RX_MVP, what's your opinion? Comment below:

There is no way hedge fund industry as a whole outperforms market with trillions of AUM. So net of fee it definitely underperforms

8y 
eignenvector, what's your opinion? Comment below:

Like brofessor said again HF and other managers cant outperform the market because they are the market. And I don't think it is fair to compare the aggregate of hedge fund returns to a single benchmark like the S&P as it has been alluded to before, some strategies goal is not to try and outperform the S&P. I feel if you want alternative exposure as part of an asset allocation investing in a FoF strategy or directly investing in a high quality HF manager that have appropriate benchmarks is a better use of capital.

"When you expect things to happen - strangely enough - they do happen." - JP Morgan
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8y 
eignenvector, what's your opinion? Comment below:

I happened to move here as soon as LeBron announced he was leaving, but I don't think most here cared from the beginning. They are just realizing it is football season.

"When you expect things to happen - strangely enough - they do happen." - JP Morgan
8y 
jankynoname, what's your opinion? Comment below:

This paper by Cliff Asness (AQR) is relevant here. Hedge funds generally provide some diversification benefit, although as a group they tend to underperform the broader equity market. It's not clear that this diversification benefit is statistically different from a lagged beta strategy (e.g. see table 4a/4b).

http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150_advanced_investments/asness_crail_liew_hedge_funds_hedge_JPM.pdf

Best Response
8y 
ArcherVice, what's your opinion? Comment below:

@"JDimon" If you're simply looking for performance metrics, those questions are easily answered by Google.

These types of questions indicate a poor understanding of how the industry works. The game is not to track the market on the street, the objective of paper is to beat the market so they attract money from other managers. That is accomplished by building a book of stocks that outperform. Paper will reduce positions in individual names, and buy ETF's to avoid underperformance (the death nail of a money manager) because their analysis of those securities indicates that those sold will underperform the general market....

You view this as a stock market, when in fact it is a market of stocks, managed by people, competing for business. There are far more funds managing money than there are stocks in the market. To put the recent market action into perspective, 220 stocks are up 10% the past month while over 1.4k stocks are down >10% and paper has been crowding into ETF's while trimming the fat. Is any of this making sense?

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8y 
user39, what's your opinion? Comment below:

Short answer: before fees, a few consistently do; a lot don't. After fees, almost none consistently do.

8y 
zltg, what's your opinion? Comment below:

That's beside the point. You have so many different strategies and objectives that you can't pick a correct benchmark. It is absolutely wrong to compare returns of an absolute return fund with a market, their benchmark would be 0 (or the risk free rate).

8y 
jcpenny, what's your opinion? Comment below:

Wrong question to ask. Better question is whether they generate alpha. Most hedge funds run books with less than 100% market exposures. If they have 20% market exposure and get 7% annually, they are still superstars.

TLDR: Look at sharpes and risk adjusted returns

Pennies from JcPenny
  • 1
8y 
GregMadeMeDoIt, what's your opinion? Comment below:
jcpenny:

Wrong question to ask. Better question is whether they generate alpha. Most hedge funds run books with less than 100% market exposures. If they have 20% market exposure and get 7% annually, they are still superstars.

TLDR: Look at sharpes and risk adjusted returns

Yeah, this is a good point. My real estate company was working closely with a large hedge fund that was about 50% cash, so if they were able to identify some superstar investments then their 8% total return could be a pretty decent risk-adjusted return (given that half the portfolio was in cash or marketable securities).

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8y 
SilenceDoGood, what's your opinion? Comment below:

"So hedge funds is supposedly a vague term, right, referring to entities that invest via like trading systems and things like that." do you even English?

The term "hedge fund", as it is properly used today, has nothing to do with the actual strategy of the firm. It refers to the legal structure of the investment vehicle.Its a well known, empirically determinable, fact that in aggregate these funds under perform the market, on a risk adjusted basis, net of fees.

I have to argue against @"thebrofessor"'s stipulation that hedge funds comprise capital markets in their entirety as they are a fringe group within the Asset Management industry. So now hedge funds are not "the market".

  • 2
8y 
thebrofessor, what's your opinion? Comment below:

I missed you too bro.

if you reread my post, I never said HF managers were the market. I meant that all of the participants I listed (PWM, traders, AM firms, HF, etc) and the ones I didn't list (endowments, pensions, insurance companies, family offices, and more) are "the market." it's an important point that no one subset of the market is "the market," but people tend to forget that it's impossible for all market participants to outperform because all market participants are "the market."

also, stop calling out people on English when you have grammatical and technical errors in your post. get off your high horse.

8y 
SirTradesaLot, what's your opinion? Comment below:

Edit: Nevermind. I don't want to get roped into a pointless discussion.

8y 
Marcus_Halberstram, what's your opinion? Comment below:

Do ALL hedgefunds in aggregate beat the markets over the long-term? Some say that empirical data says no.

But do select hedge funds outperform the market? Absolutely.

There are hedge funds who have been up on a monthly basis for +90% of the time over the course of several years. There's one in particular I know of that was up for something like 280 out of 290 months. That is mind boggling.

When you invest over the course of several years and consistently generate IRRs north of 35% YoY with the lowest returning month being something like 15-20% returns.... your AUM compounds very rapidly and you now have to find new places to deploy this capital

These (very few) funds end up becoming a victims of their own success and they become an asset gathering rather than an alpha finder... so their overall returns trend downward and their fund ends up reverting to the mean (or somewhere thereabouts).

Array
  • 3
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8y 
WalMartShopper, what's your opinion? Comment below:
Marcus_Halberstram:

Do ALL hedgefunds in aggregate beat the markets over the long-term? Some say that empirical data says no.

But do select hedge funds outperform the market? Absolutely.

There are hedge funds who have been up on a monthly basis for +90% of the time over the course of several years. There's one in particular I know of that was up for something like 280 out of 290 months. That is mind boggling.

When you invest over the course of several years and consistently generate IRRs north of 35% YoY with the lowest returning month being something like 15-20% returns.... your AUM compounds very rapidly and you now have to find new places to deploy this capital

These (very few) funds end up becoming a victims of their own success and they become an asset gathering rather than an alpha finder... so their overall returns trend downward and their fund ends up reverting to the mean (or somewhere thereabouts).

who the fuck shitted on this post? must be some edward jones advisor...

If the glove don't fit, you must acquit!
  • 3
8y 
Esuric, what's your opinion? Comment below:

They take excessive risk, invest in relatively illiquid assets and claim to 'generate alpha.' In many cases, they take excessive risk and can't even outperform broad indices comprised of mature blue chips. There are of course some that are successful, and even on a risk adjusted basis, outperform the general market.

“Elections are a futures market for stolen property”
  • 1
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8y 
Bullet-Tooth Tony, what's your opinion? Comment below:
Esuric:

They take excessive risk, invest in relatively illiquid assets and claim to 'generate alpha.' In many cases, they take excessive risk and can't even outperform broad indices comprised of mature blue chips. There are of course some that are successful, and even on a risk adjusted basis, outperform the general market.

8y 
Esuric, what's your opinion? Comment below:
Bullet-Tooth Tony:
Esuric:

They take excessive risk, invest in relatively illiquid assets and claim to 'generate alpha.' In many cases, they take excessive risk and can't even outperform broad indices comprised of mature blue chips. There are of course some that are successful, and even on a risk adjusted basis, outperform the general market.

So this is your attempt at a rebuttal?

“Elections are a futures market for stolen property”
  • 2
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8y 
SanityCheck, what's your opinion? Comment below:
Esuric:

They take excessive risk, invest in relatively illiquid assets and claim to 'generate alpha.' In many cases, they take excessive risk and can't even outperform broad indices comprised of mature blue chips. There are of course some that are successful, and even on a risk adjusted basis, outperform the general market.

Lol.

8y 
Brent Crude, what's your opinion? Comment below:

I like how most of you are dripping with disdain for OP because he asked an honest question. It's worth asking if that true usefulness of hedge funds is worth 2/20 or if the Edward Jones guy could do a comparable job.

And spare me a repeat of the argument for hedge funds because I agree with it. But this industry draws the best, brightest and greediest, it's okay to ask why returns at least "seem" crappy

8y 
GregMadeMeDoIt, what's your opinion? Comment below:

I was under the understanding that the name "hedge fund" is a relic from what they originally were supposed to be--funds that used certain financial mechanisms to reduce risk and improve risk-adjusted returns. I understood that hedge funds, despite their name, no longer really reflect their names. I could be wrong.

8y 
cauchymonkey, what's your opinion? Comment below:

it is hard to precisely define "beat" and it is not as simple as using things like sharpe ratios (which collapse a whole distribution into a single number).

moreover, probabilities of non-recurring events can't be observed.

however there are definitely funds that beat the market on most measures for example the renaissance medallion fund

8y 
ArcherVice, what's your opinion? Comment below:

He makes valid points, I don't agree with everything he's stated but his underlying point is accurate IMHO. If I had to "wager", I'd say his contention is accurate about HFs and they will be in permanent decline after this market cycle transitions again.

8y 
jankynoname, what's your opinion? Comment below:

I think the debate about absolute returns at hf's is an important one. We can argue about whether some funds generate positive alpha or have decent Sharpe's, but the point is the vast majority underperform the markets on a ABSOLUTE basis, particularly after expenses. For typical investors with long time horizons, including pension funds/endowments with virtually infinite time horizons, they should not be looking to reduce risk and exchange it for (allegedly) higher "risk-adjusted returns". They should be looking to go long risk, take lots of it during times of crisis and over their 30, 40 , 50+ year time horizon they will be much better off for doing it. That's why I think the HF fee structure is so bogus. It's a service that could potentially be valuable for some investors, (e.g. wealthy older retired persons with

8y 
RX_MVP, what's your opinion? Comment below:
jankynoname:

I think the debate about absolute returns at hf's is an important one. We can argue about whether some funds generate positive alpha or have decent Sharpe's, but the point is the vast majority underperform the markets on a ABSOLUTE basis, particularly after expenses. For typical investors with long time horizons, including pension funds/endowments with virtually infinite time horizons, they should not be looking to reduce risk and exchange it for (allegedly) higher "risk-adjusted returns". They should be looking to go long risk, take lots of it during times of crisis and over their 30, 40 , 50+ year time horizon they will be much better off for doing it. That's why I think the HF fee structure is so bogus. It's a service that could potentially be valuable for some investors, (e.g. wealthy older retired persons with <5-10 year horizons), but they certainly shouldn't be getting anywhere close to 2+20, or even 1+10 for this.

I think what you said applies to personal 401K (esp those at 20ish) but not pension fund/endowment fund. 20ish or 30ish people's 401K should be always stock (mkt etf).

All those large institutional investors have liabilities to pay out in both short term and long term. A large loss before large pay out will severely impact fund performance. That's exactly why those investors like hedge fund since hf suppose to provide stable absolute return.

  • 2
8y 
DickFuld, what's your opinion? Comment below:

Pension funds spend money every year, which means long-term returns are not the only thing that matters to the final outcome. Reducing volatility helps mitigate the path dependent nature caused by these cash outflows. Selling assets at inopportune times is why path dependency matters to the bottom line. Therefore, what you have stated is incorrect.

8y 
jankynoname, what's your opinion? Comment below:

I mean i guess but pensions & endowments typically only spend about 5% of assets each year. This doesn't seem like enough to overthink timing of outflows. Just stay fully invested in the market and as long as the market doesn't go down 80%+ you'll be better off over the long run. The last thing they want is to have HF-like returns when the market is at a trough, and miss out on the greatest upside portion of a cycle.

8y 
SanityCheck, what's your opinion? Comment below:

Except pension funds/endowments are not 100% invested in HFs. It's usually a very small % of AUM for them and for that purpose they definitely should be looking at alternative investment vehicles that provide risk adjusted returns as part of a larger portfolio.

Fees are a different story, but it's why I rail against mutual funds more than hedge funds. Business continuity is not a good incentive. The fund business is very lucrative upon AUM scale, but it should not be this way. No one should take hundreds of millions in management fees for a team of 10 without guaranteed performance. Unfortunately, you'll never stop the herd/follower mentality inherent in human beings.

8y 
StreetMonkey9, what's your opinion? Comment below:

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8y 
GregMadeMeDoIt, what's your opinion? Comment below:

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8y 
Bullet-Tooth Tony, what's your opinion? Comment below:

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