Hedge Funds Recover From Early Losses To Beat US Stocks in 2005

by Carla Johnson, Investors Offshore.com

11 January 2006

Despite failing to achieve the double digit returns that made them popular at the turn of the century, hedge funds still managed to outperform broader stock market indices in 2005 as a late surge compensated for poor returns delivered earlier in the year.

According to data published by Chicago-based Hedge Fund Research, the average hedge fund managed to attain a respectable return of 9.18% last year. While this was only slightly better than the 9.03% average return seen in 2004, and substantially lower than the 19.6% average return achieved in 2003, when compared to the 3% return from the S&P 500 last year, hedge fund performance does not look as bad as some had feared in 2005.

However, HFR's data suggests a correlation between growth in the hedge fund industry and a decline in returns since 2000. Between 1990 and 1999, hedge fund returns rose at an average annual rate of 16%. Since 2000, when assets under management by hedge funds doubled to more than $1 trillion, average annual returns have dipped to 7.5%.

Forced to compete for diminishing returns in what many perceive to be an overcrowded market place, there was a high hedge fund casualty rate last year as 484 funds shut down in the first nine months of 2005, or 5.7 percent of the total - the highest rate since HFR began collecting data on fund closures in 1996. The previous record was 297 funds, or 5.5 percent, in 2002.

Hedge fund investors are expected to place more assets into funds employing strategies based on equities and macro-economic trends in 2006 as they go in search of higher returns after a year in which hedge fund performance has disappointed some.

Equity-based hedge funds, or 'equity long-short' strategies, were the best performers last year, posting average returns of 10.7%. Distressed securities funds were also notable performers last year, gaining 9% on average, as were event driven strategies, which bet on events such as bankruptcies and management restructurings, gaining 7.6% on average. Macro funds, which bet on trends in global stock markets, interest rates, commodities and currencies, gained 6% on average in 2005.

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