Hedge Fund Mid-Term Report Card

While we’re all accustomed to numerical (70%, 80%, 90%) and letter grades (A, B, C), there was a time in our distant youth when our academic prowess was judged simply to be “unsatisfactory” or “satisfactory”. It’s hard to get that jazzed about a “satisfactory” grade (Whoo-hoo! Jimmy got straight “satisfactories” on his report card!). But hey, it’s better than the alternative.

And that’s just how the hedge fund industry was recently graded by investors according to this report published last week by France-based Olympia Capital Management. The firm writes that “…hedge funds have delivered the performance in line with investors’ expectations.”

After last year’s performance, “in-line with expectations” is a major victory. (Of course, comparing the performance of hedge funds and the markets last year was like comparing the performance of a solid student with their rowdy and delinquent peers. The student was led astray by these bad kids.)

Hey investors, redeem this!

The report contained a number of interesting findings. It finds that very few hedge funds actually changed their liquidity terms in response to last year’s poor performance. In fact, the report analyzed nearly 2700 funds and found that more funds actually reduced their liquidity than they increased it.

This sounds totally counter-intuitive at first, but Olympia chalks it up to the fact that hedge funds trading illiquid instruments actually smartened up and aligned their own liquidity with that of their underlying instruments. This is a good thing for investors who value hedge funds for their ability to invest in illiquid instruments. The trick, as always, is to ensure that a fund truly requires restrictive liquidity to execute its stated investment strategy.

The harder they fall, the harder they bounce back

The report also compares the YTD performance of various hedge fund strategies with performance last year. It will come as no surprise to industry veterans that the strategies that fell the hardest last year are also this year’s winners.

Note that managed futures and global macro (two highly liquid strategies) managed to get good marks in both years.

Funds of funds singing from the same songbook again

After a year when fund of funds performance was quite divergent, that sector of the industry seems to be on the same page again. The firm ranked funds of funds last year and found that the best and the worst 2008 funds had average 2009 returns that were in the same ballpark. (In keeping with the chart above, last year’s dogs seem to outperform, on average, this year.)

Skeptics of statistics might point out that this chart might just indicate that there is no persistence in fund of fund returns, not that fund of funds are all cranking out 5% YTD this year. After all, there could simply be a new “Decile 10″ in 2009 that is made up of a selection of funds drawn from across all 2008 deciles. But this still wouldn’t explain the propensity for last year’s relative stars to – on average – underperform last year’s dogs.

There’s lots more in this report, including the firm’s view (Bullish, Neutral or Bearish) on each hedge fund strategy for the remainder of 2009.

The bottom line is that the hedge fund industry seems to have finished its Saturday detention, cleaned up its act and is now hanging out with the smart kids. That all adds up to one thing as far as investors are concerned: Satisfactory. And that’s a welcome change.