Study: With Hedge Funds 'Proceed with Caution'

June 6, 2006 ( - A new study of hedge fund returns asserts that most investors can generate similar returns from a well diversified portfolio of stocks and bonds as they can in an average hedge fund of funds.

A news release from the San Francisco-based Presidio Financial Partners said its Demystifying Hedge Funds II analysis compared the performance of a diversified portfolio of investments to the HFRI Fund of Funds Composite Index, the industry benchmark for hedge fund of funds (HFOF).

According to the announcement, the analysis found that from April 2000 to March 2006, the diversified portfolio generated an average annualized return of 6.3%, compared to 5.2% for the HFRI Index.  The news release said the model diversified portfolio consisted of: 40% taxable bonds (Lehman Aggregate Index), 20% US large cap (S&P 500), 10% high yield bonds (ML Lynch High Yield Master II), 15% international equity (MSCI EAFE), 10% US small cap (Russell 2000), and 5% emerging market equity (MSCI EMF Index).

“Demystifying Hedge Funds II is not intended to dissuade individuals and institutions from hedge funds, which remain an important component of a total asset allocation strategy,” said Jeff Spears, Managing Director of Presidio Financial Partners, in the news release. “The point is that as hedge funds become more popular, investors need to proceed with caution. Finding the top performing funds is exceedingly difficult, but there are hedge funds that are absolutely worth the additional fees and risk.”

The study also concluded that only 12 to 15 of the more than 1,000 hedge fund of funds – and no more than 250 of the more than 8,000 individual hedge funds – deliver performance in line with their higher fees. The analysis reached that conclusion after evaluating seven key factors:

  • A forward-looking view about which strategies are likely to perform well in the future.
  • Access to top-tier talent – A good percentage of HFOFs have a few flagship hedge funds as anchor managers with whom they have good relationships.  The quality of hedge fund managers beyond those few is often mediocre to poor.
  • A strong pipeline of prospective managers – HFOFs must constantly look to upgrade the quality of the investment program. 
  • Deep knowledge of hedge fund industry/strategies
  • Sophisticated risk management systems
  • Ongoing due diligence and monitoring
  • Willingness to stay small.