Hedge Fund Index Group Proves It's Good to Follow the Smart Money

by Maz Jadallah

This week the latest hedge fund performance results were released. The New York Times blogged about this year’s performance numbers under the header “For Hedge Funds, Best First Half in 10 Years”. Indeed, according to Hedge Fund Research, hedge funds returned an average of 9.73 percent in returns year to date through June 24.

Not bad, but we thought it would be instructive to compare those results against our own Hedge Fund Index fund group. If you recall, this fund group combines every hedge fund that AlphaClone tracks. We also have an Institutional Investor Index group (combines institutional investors we track) and an AlphaClone Index group (combines all funds we track). We created our index groups to be able to tap the collective intelligence across entire “populations” of funds – hence the term “index”.

We select the Top Holding/50% Hedged clone for the Hedge Fund Index group as being fairly representative of the group’s collective intelligence at least with respect to long US equity securities. There’s no dissertation behind why we chose this clone – we simply assumed that a) most hedge funds have a largely disproportionate portfolio allocation to their top equity holding and b) most of them hedge against risk in some way. Thus, it made sense to look at a clone that invested in the top holding for each fund in the group (i.e. the clone has around 150 holdings) and was also hedged.

As a reminder, the simulation of a 50% hedged clone assumes the portfolio is 100% long and 50% short the S&P 500 Total Return Index (we do not account for the costs of the hedge or adjust for things like short rebates). If you don’t like our rationale you can develop your own because AlphaClone allows you to instantly select any clone you like for the group and view that clone’s ten year performance at various hedging levels.

OK, enough set up – how does the clone perform? Year to date the clone is up nearly 14% to June 30. That’s 50% better than the numbers released by Hedge Fund Research! Since 2000, the clone has beat the S&P500 Total Return Index by 8.3 percentage points annualized (5.3% return for the clone vs. negative 3.0% for the index). We include the hedged clones’ annual performance numbers since 2000 below. Judge for yourself but we would suggest that “it’s good to be the smart money”.

HEDGE FUND INDEX GROUP

TOP HOLDING CLONE/50% HEDGED

As of June 30, 2009

	Top Holding	S&P 500TR
2000	4.30%	-8.20%
2001	1.50%	-11.90%
2002	-9.30%	-22.10%
2003	29.80%	28.70%
2004	16.90%	10.90%
2005	9.80%	4.90%
2006	16.40%	15.80%
2007	6.70%	5.50%
2008	-26.30%	-37.00%
2009	13.90%	3.60%

Comments

[riskmgr:]

if your "clone index" has strategy weights and more importantly, risk levels disproportionate to that of the hfr index, we're just comparing apples to oranges here and there's not much to discuss..

Jul 02 03:23 PM

[BRUCE E. W.:]

The question as to who or what caused the massive decline of value across global markets during the week around March 9, 2009 has been attributed to massive "mechanical" shorting. If the Hedge funds are so deliberately behind so much of this shorting than the "smart money" is just another zero sum game of shifting losses to others rather than simply distributing risk to dilute the cost of those losses. The economy of derivatives was throttled by Hedge Funds and their expansive platform of debt recycling. While these Hedge funds point to big banking as the core problem, its high time that a comprehensive and critical look at Hedge Funds was placed on the public table for scrutiny. The unfortunate problem with a profit index is that it seems to call only for more blind investors to throw their money over to these Financial Giants.
Maybe we should follow the so-called "smart money" but not with more fuel to the fire. Far better to "follow the money" as a trail to discovery and foundation. I for one would like to know more about how much pivoted on that massive decline in the beginning of March which has never been comprehensively explained.

Jul 03 11:02 PM