Hedge funds outperformed stocks and bonds on a risk-adjusted basis in 2016, producing net gains of about US$120 billion net of fees, estimates the Alternative Investment Management Association (AIMA) and data provider Preqin.
Risk-adjusted outperformance is highly valued in investments since it reflects volatility as well as net returns.
Hedge funds’ risk-adjusted return, as measured by the Sharpe ratio, was 1.45 for the year, ahead of the S&P 500 (1.1), MSCI World (0.68) and Barclays Global Aggregate (0.20) indices. (The Sharpe ratio is calculated by subtracting the risk-free rate — usually the return on U.S. treasuries — from the fund or index performance, net of fees, and dividing this by the fund or index’s volatility. The higher the ratio, the better the risk-adjusted return.)
On an absolute basis, hedge funds returned 7.4% last year, reveals the Preqin All-Strategies Hedge Fund index.
The research by AIMA and Preqin also addressed the performance of hedge funds that are open to outside investors and those that are closed to investors. On a five-year annualized basis, closed funds returned 6.42% per annum on average, while open funds earned 6.75% per annum on average.
The analysis, based on a database of more than 3,000 funds, found that hedge funds also outperformed stocks and bonds on a risk-adjusted basis over three years and five years, with Sharpe ratios of 0.97 and 1.49, respectively.