Hedge Funds Aren't Beautiful

Jahnke, William
February 2004
Journal of Financial Planning;Feb2004, Vol. 17 Issue 2, p22
Academic Journal
Hedge funds are being promoted, as of February 2004, as having an important role in a diversified portfolio of investors of moderate wealth. Advocates for investing in hedge funds point to their superior absolute returns, superior risk-adjusted returns and low correlation with stock market returns. But the claim that investing in hedge funds will increase portfolio return and lower portfolio volatility for investors is an illusion based on bad performance data, faulty analysis and wishful thinking about future prospects. Many hedge funds are closed to new investments and some successful hedge funds are returning capital to their outside investors. Stock market returns are generated by the pricing of systematic risk factors, while hedge funds depend on the selection skill of managers to produce performance. While the promise of high absolute hedge fund returns is the primary attraction of hedge funds, the case is also made that hedge funds offer an added advantage: a higher return-to-risk ratio than stocks, bonds and cash measured by the Sharpe ratio. The inclusion of hedge funds in a portfolio along with traditional stock, bond and cash investments will significantly improve a portfolio's mean-variance characteristics.


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