The vast majority of institutional investors’ hedge fund portfolios underperform simple investable benchmarks, with fees responsible for making most hedge fund portfolios “bad investments”, according to a study.  

The study, carried out by Canadian research company CEM Benchmarking, was commissioned by 27 large institutional investors from Denmark, the Netherlands, Sweden and the UK, among others.

The study found that most hedge fund portfolios “look surprisingly like simple stock/bond portfolios”, according to Alexander Beath, senior research analyst and lead author of the study.

“Worse,” he added, “what little alpha is generated goes to the hedge fund managers and then some.”

According to CEM Benchmarking, the study found that institutional investors’ hedge fund portfolios have over 15 years outperformed simple stock/bond portfolios by 0.97% before fees but that “fees have made most hedge fund portfolios bad investments with net alpha of -1.88”.

The company analysed the realised hedge fund portfolio returns of more than 300 large global investors.

Half of these have invested with hedge funds for five years or more, with analysis of these return histories showing that, “for most funds, the performance can be replicated at much lower cost by simple equity/debt blends”.

The average correlation to simple stock/bond portfolios was 84% and more than 90% for more than half of funds, according to CEM Benchmarking.

“These results would not be disappointing except for the fact 70% of funds underperformed the simple benchmarks,” it said, “and the average fund underperformed by -1.88%.”

Thirty percent of the surveyed institutional investors had hedge fund portfolio returns that beat the benchmark, and they had the following features in common, according to CEM Benchmarking:

  • Funds with long histories investing in hedge funds tend to outperform those with short histories
  • Funds with lower correlation to equity/debt blends tend to outperform those with high correlations
  • Funds with low cost implementation tend to outperform those with high cost implementation

CEM Benchmarking said most institutional investors benchmarked their hedge fund portfolios against speciality hedge fund indices or cash-based benchmarks, and that both styles were “flawed”.

Speciality hedge fund indices suffer from survival biases, it said, while cash-based benchmarks show no correlation to hedge fund returns.

Neither of these types of indices is investable or representative of a low-cost viable alternative, it noted.

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