Hedge Funds

Hedge funds have a number of advantages compared to traditional investments:

	Hedge Fund Managers	Traditional Money Managers
Performance Objective	Absolute Return	Relative Return
Manager Co-Investment	Yes	Seldom
Performance Based Compensation	Yes	No
Seek to Avoid	Loss	Index Underperformance
Market Exposure	Variable, Opportunity Based	Fully Invested

Hedge funds are designed for absolute return, meaning trying to beat zero, inflation, or T-Bills while traditional managers try to beat a market index and don’t care about losses as long as they lose less than their index. 

Hedge fund managers tend to invest most of their money in their own funds while traditional managers tend to have very little of their money in their funds. Hedge fund managers get a percentage of assets but make most of their money by charging a percentage of performance (typically 20%). Traditional managers only charge a percent of assets.

One way to look at this would be to surmise that hedge funds are more expensive, which is true. Another way to look at it is that the more money the hedge fund manager makes for the client the more they make for themselves. Finally, alternative investment managers seek to avoid losses while traditional managers just seek to avoid underperforming their index.

The biggest benefits of hedge funds are their attractive risk/reward profile vs. other investments and their ability to provide protection from losses. Below is a chart comparing hedge funds, represented by the HFRI Hedge Fund of Funds Index with the S&P 500:

1990-2005	Return	Standard Deviation (Risk)
S&P 500	10.55%	14.32%
Hedge Funds- HFRI Fund of Funds Index	9.89%	5.54%

From 1990-2005, the S&P 500 did better than alternatives by 64 basis points but took almost 3 times the risk to do it. The next chart shows the cumulative performance of the S&P 500 and the Lehman Brother’s Bond Index over all down months from 1990-2005 along with hedge fund performance over the same periods:

Cumulative Down Months S&P 500 -91%	HRFI Over Same Period .02%
Cumulative Down Months for Lehman Bond Index -35.2%	HRFI Over Same Period 36.8%

Adding up all the down months in the S&P 500 during this period would equate to a negative 91% return. Adding up hedge fund returns over the same period would be positive .02%. Hedge funds vs. bonds are even more impressive. Adding up down months in bonds would yield a negative 35.2% return. Over those same periods Hedge Funds would have been up 36.8%.

Hedge funds have the ability to provide stock market like returns with less risk.