INDICES COMPARISON

Hedge Funds Indices Compared to Bonds and Equity Indices



Hedge Funds Indices Compared to Bonds and Equity Indices

Introduction

In this comparison paper we look at hedge-fund performance, with an eye toward assessing risk-adjusted return performance. First, we analyze the overall performance of hedge funds versus traditional assets such as equities. We then examine the performance of hedge funds in the context of a Capital Market Line (CML) assessment of performance versus risk. Our hedge-fund performance is based on the Credit Suisse/Tremont HFI.

Discussion

Following that, we look at a breakdown of the risk-adjusted performance of 10 hedge-fund “styles” as represented by Credit Suisse/Tremont Hedge-fund Indices. The specific names of the 10 hedge-fund styles covered by Credit Suisse/Tremont include Convertible Arbitrage, Fixed Income Arbitrage, Event-Driven (including, E.D.-Distressed, E.D.-Risk Arbitrage, and E.D. Multi-Strategy), Global Macro, Long-Short Equity, Equity Market Neutral, Dedicated Short Bias, Managed Futures, Emerging Markets, and Multi-Strategy (combination). In our style-based performance assessment, we look at annualized returns, standard deviation of return (total risk), and risk-adjusted performance, measured by the Sharpe ratio. The Sharpe ratio is the annualized fund premium (return over risk-free rate) divided by the standard deviation of asset or portfolio return.

Fig1: Hedge Funds vs. Traditional Benchmarks1994-2011 0.00%

We first assess the performance of the Credit Suisse/Tremont HFI versus traditional assets including the S&P 500, the MSCI World Index, and U.S. Treasury Bills (a risk-free asset). In this context, Figure 1 shows the annualized returns over the 1994 to 2011 period (twelve years since inception) on the Credit Suisse/Tremont HFI versus three well-known assets. Based on annualized returns alone, hedge funds as an alternative asset class provided a return which, at about 10.5%, is competitive with that earned on U.S. equities. Moreover, the twelve-year HFI performance is considerably better than that observed on the MSCI World index and (not-surprisingly) U.S. Treasury Bills, with annualized returns of 8.4% and 3.84% respectively.

Figure 2 shows the performance of the Credit Suisse/Tremont HFI relative to a Capital Market Line. While Figure 1 reveals that the annualized return to hedge-fund investing is competitive with that of equity indexing (to the S&P500), Figure 2 highlights the benefit of hedge funds from a risk management perspective. Specifically, the latter figure shows that the annualized standard deviation on the Credit Suisse/Tremont HFI over the 1994 to 2011 period is about 8% (actually, 7.88%), while the comparable risk measure for the S&P500 was considerably higher, at 15% (14.77%).

Moreover, Figure 2 shows that a CML-based strategy that combines the Credit Suisse/Tremont HFI with the risk-free asset provides better returns on a risk-adjusted basis than that observed on a two-asset portfolio consisting of the market index (S&P 500) and the risk free asset. In other words, the Sharpe ratio (slope of the CML) for the Credit Suisse/Tremont HFI is considerably higher than that observed on the S&P500, at 0.87 and 0.45, respectively.

We now assess the performance of hedge funds by fixed income and equity “styles”.

Capital Market Line (CML)

Fig 2 :Credit Suisse/Tremont Hedge Fund Index ...