HEDGE FUND INDEX PERFORMANCE AND RETURN CHARACTERISTICS

Abstract

Hedge funds’ ability to achieve superior returns when compared to broad market indices has prompted numerous studies on their performance characteristics. Hedge funds seem to achieve absolute returns regardless of the market conditions, and they seem to achieve this with seemingly lower risk. This study examines whether hedge fund indices are capable of achieving superior risk-adjusted returns than a broad market index. Moreover, the aim is to use a multifactor to better explain the return characteristics of the indices and to determine whether a more localized model can fare even better.

The dataset is comprised of monthly returns between 2004 and 2014 and includes indices following different investment strategies with very different return characteristics from five different data providers. The data is studied with three regression models with an aim to build on the previous results. First a simple regression model is used to compare the performances of the indices to the S&P 500 total return index. Then a multifactor model derived by Fung & Shieh in 2004 is used to explain the return characteristics of the indices, and finally a localized adaption of the multifactor model is used for indices comprised of Nordic hedge funds.

The results imply that hedge fund indices are capable of achieving superior risk-adjusted returns. Furthermore, the explanatory power increases with the multifactor model and a more complex model is better at identifying where the returns originate from, although the model struggles with especially managed futures indices. Also, the localized adaption of the model is able to further improve on the results achieved with the standard model.