Study: Hedge Fund Returns Expected to Moderate

March 28, 2005 ( - Not only may hedge fund investors have to make do with lower returns in coming months, but the systemic risk of the hedge fund industry is increasing.

That was a key conclusion of a new paper, Systemic Risk and Hedge Funds, published by four researchers for the National Bureau of Economic Research, Dow Jones reported.

Conclusions from the study are only tentative because the authors said a conclusive assessment of the systemic risks posed by hedge funds requires certain data that are not currently available and unlikely to become available in the near future. Because of that data problem, the researchers said they can’t determine the magnitude of current systemic risk exposures with any degree of accuracy.

According to the researchers, the hedge fund industry has grown tremendously over the last few years, prompted by demand for higher returns in the face of stock market declines and mounting pension fund liabilities. Further, these massive fund inflows have had a material impact on hedge fund returns and risks in recent years.

The authors said the risks facing hedge funds are “nonlinear and more complex” than those facing traditional asset classes. “Because of the dynamic nature of hedge fund investment strategies and the impact of fund flows on leverage and performance, hedge fund risk models require more sophisticated analytics and more sophisticated users,” they said.

This and other factors, including increased mean and median liquidation probabilities for hedge funds in 2004, imply that systemic risk is increasing, they added.

The paper was authored by Nicholas Chan and Shane Hass, both of AlphaSimplex Group, LLC, Cambridge, Massachusetts.; Mila Getmansky of the Isenberg School of Management at the University of Massachusetts; and Andrew Lo at the Sloan School of Management at the Massachusetts Institute of Technology.

A copy of the paper can be ordered  here .