Do hedge funds, in aggregate, generate positive alpha? If they do, that’s quite
impressive, seeing as how mutual funds, in aggregate, generate significantly
Of course, the question is hard to answer, for two main reasons: Firstly, measuring
alpha is very hard, and secondly, getting data out of hedge funds is even harder.
Looking at indices certainly doesn’t help, since they don’t measure alpha and
they suffer from dreadfull survivorship bias.
Stultz has taken a stab at summarizing the research on this subject:
Ibbotson and Chen (2005) examine the performance of hedge funds from January
1999 to March 2004. Their study uses 3,538 funds. After adjusting for various
sample biases, they conclude that… the average alpha of the funds is 3.7
percent. With this estimate, the alpha of hedge funds is particularly impressive
when compared with the alpha of equity mutual funds. Malkiel (1995) estimates
the alpha of all equity mutual funds at -3.20 percent…
A study by Kosowski, Naik, and Teo (2005) using an extremely large database
comes to the conclusion that the average alpha across hedge funds from 1994
to 2002 is 0.42 percent per month after adjusting for the problems in evaluating
hedge funds we discussed. However, the alpha in this study is not statistically
Fung, Hsieh, Naik and Ramadorai (2006) investigate the performance of funds-of-funds.
The authors argue that the data is much better for funds-of-funds than it
is for individual hedge funds and does not suffer seriously from the problems
discussed earlier. They consider three separate periods: January 1995 to September
1998, October 1998 to March 2000 and April 2000 to December 2004. They find
that the average fund-of-funds has a significant positive alpha during the
second period they consider, but the alpha is insignificant in the two other
The academic bottom line on hedge fund performance is captured well by these
studies. If one picks randomly a hedge fund, one should have a positive
insignificant alpha after fees.
In other words, hedge funds, before fees, really do, in aggregate, generate
substantial alpha. But they keep most of that alpha for themselves, in the form
of fees, leaving very little left over for investors.
Stultz also looks to the future, where, according to the summary at CXO,
the small positive alpha of hedge funds in aggregate is likely to move toward
the negative alpha of the mutual fund industry in the coming years.
Personally, I’ve read through Stultz’s report, and I can’t find him saying
that in quite as many words, although he does say that there’s likely to be
more of a convergence between hedge funds and mutual funds as the former become
larger and more regulated and the latter start embracing the kind of strategies
presently used only by hedge funds.
says that Stultz predicts lower hedge fund returns over the next ten years as
new managers enter the industry who aren’t as good as the old managers –
again, that’s there between the lines, but not really in so many words.
Even so, it’s interesting to me that hedge funds have, in aggregate, generated
positive alpha at all. And I wouldn’t be at all surprised if those days are
now at an end.