The Alternative Investment Management Association (AIMA), the global hedge fund industry association, has published a new educational guide to understanding hedge fund performance.

The guide, ‘Apples and apples: How to better understand hedge fund performance’, says comparing hedge fund performance to the S&P 500 can be an "apples and oranges" comparison. It proposes five steps to improve understanding of hedge fund performance:

  • Look at risk-adjusted returns: The guide reveals that hedge funds consistently outperform US equities (as measured by the S&P 500), global equities (MSCI World) and global bonds (Barclays Global Aggregate ex-USD Index) on a risk-adjusted basis, a crucial measure for investors. Even during the stock-market rally of recent years, hedge funds performed better on a risk-adjusted basis than the S&P 500 and MSCI World, according to the guide.
  • Look at long-term data: The guide says that short-term data such as monthly comparisons can be misleading and argues that greater clarity is gained by looking at long-term figures. It points out that hedge funds have outperformed the main standalone asset classes over the 10 years to the end of 2013 both in terms of "headline" returns and on a risk-adjusted basis.
  • Look at the returns by strategy: The guide explains how hedge fund strategies are enormously diverse and have different characteristics which can play different roles in investor portfolios. It also stresses that hedge funds are not an asset class and that there is no such thing as the "average" hedge fund.
  • Compare with the most relevant asset class: The guide says that reference should be made to how different strategies perform in relation to the most relevant asset class to that strategy. In other words, it may make much more sense to be comparing a particular strategy to bond performance than equities.
  • Be aware of differences between hedge fund indices: The guide notes that during the five years to the end of 2013, the main hedge fund indices produced notably different results, reflecting variations in constituency and methodology.

Jack Inglis, CEO, AIMA, said: "It is striking that recent surveys have highlighted high levels of investor satisfaction in hedge funds at a time when many commentators have claimed that the industry is being out-performed by the ‘market’. The reason for this is that investors are not allocating to hedge funds to beat the S&P 500 but to allow them to meet their asset-liability management objectives in terms of risk-adjusted returns, diversification, lower correlations, lower volatility and downside protection.

"Put simply, many investors value getting steadier returns with lower volatility over higher returns with much greater volatility. Hedge funds actually have lower volatility not only than equities but also bonds. What that means is that in terms of the risk taken, ie in risk-adjusted terms, the industry continues to out-perform."