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Hedge funds… an absolute return vehicle?

In the past decade, hedge funds [1] have grown tremendously and they have been loved by investors and fund managers alike. Managers are obviously loving the fee structure, that they have been remarkable at keeping at 1-20 (that is they receive 1% of assets per year as well as 20% of the return). And why have investors liked these costly investments? Guess? Yes exactly, the very high returns.

Over the years, as more and more hedge fund returns have entered the market, it has become increasingly difficult to generate alpha (alpha is described as the extra return a manager can generate above what a normal portfolio with the same risk would generate). As well, bigger hedge funds found it difficult to get 20% return as their assets grew. Imagine managing 100M$ and having a good 20% return year, that is great. But if you have 10 times that amount, then you need to generate 200M$ of profits to get the same return, a bit tricky. That is why a lot of the better hedge funds are considered non investable. Basically, in theory, they do not allow new investors to invest in the funds in order to maintain a high return.

But anyway, as hedge funds saw their returns going a bit down, they changed their sales tactics. Instead of promoting high returns, they said they could deliver “absolute” returns. Basically that means they could deliver a moderate return even in tough years for the market. Attractive right? Absolutely, especially in a period like this one as investors struggle for returns.

However, the problem is that in the past 12 months, the average hedge fund is not having a positive return. Say what? Yes, the return is under 0. Sure, there are many exceptions, as in all categories of investments. But overally, the hedge fund industry is having a tougher time.

And so, I heard for the first time this week from one manager that the industry should probably change its marketing again and promise beating benchmarks instead. No more guarantees of positive returns (they weren’t really guarantees anyway as there is not really a money back policy if you’re unhappy with your return!). But it will be interesting to see how the industry will evolve as it has to redefine itself and what it can offer investors. I still believe without any doubt that these investments can be a great thing. But like any other investment, nothing is certain and eventually both the investors and the firms will have to return to that reality…!



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4 Comments (Open | Close)

4 Comments To "Hedge funds… an absolute return vehicle?"

#1 Comment By Richard Wilson, hedge fund blogger On August 8, 2008 @ 11:25 am

Hi Mike,

Nice post, it is true that some hedge funds are switching back and forth on their main selling point, some of this is natural as strong points shift as the markets and competition shifts but some of it does seem to conflict with what these same firms might have said 18 months ago.

I run a investment blogs including a hedge fund blog. I wonder if we could link our two blogs together. Would you be open to exploring this idea? I have 500 articles all about hedge funds on my blog.


– Richard
Richard Wilson
Hedge Fund Blogger

#2 Comment By MoneyEnergy On August 9, 2008 @ 1:58 pm

Well, I know that when I need to learn more about hedge funds, this is the place to come. Do you know about options, too?:) Thanks for writing this. And Richard, I’ll check out your site too.

#3 Comment By The Financial Blogger On August 9, 2008 @ 2:19 pm


I started my career working in a stock options / futures back office ;-0
I’ll write about it latter on. Thx for the idea!

#4 Comment By Hedge Fund Search Digest On August 12, 2008 @ 6:02 pm

The industry itself has undergone changes – not just in its marketing. There are many more hedge funds trying to make a go of it, now, and the asset class has been moving toward mainstream. The same phenomenon you describe in reference to a single fund, non-scaleability, perhaps has some application to the hedge fund industry as a whole.