HEDGE FUNDS: Worth A Closer Look?

• Author: Dubes, Michael

Until recently, corporate asset allocation rarely included hedge funds as a component. One reason was the lack of meaningful benchmarks. Fledge funds - essentially, private pools of capital targeting wealthy individuals and institutional investors - were difficult to categorize within traditional asset allocation models. Another problem was the secrecy surrounding hedge fund holdings.

Getting hedge fund managers to share detailed information on their portfolio positions was an arduous task. In addition, many of the hedge funds most commonly employed by institutional investors were dubbed "market-neutral," purporting to out-perform traditional conservative U.S. Treasury fixed-income markets while limiting portfolio exposure to equity market fluctuations. But these funds were not meeting their objectives and appeared to be heavily correlated to underlying equity markets.

Much has changed. As an asset class, hedge funds outperformed all others during 2000. While the Dow, S&P 500 and Nasdaq dropped 6, 9 and 39 percent, respectively, the average hedge fund rose 8 percent. And the positive performance continues: For the first four months of 2001, the CFSB/Tremont hedge fund index was up 1.53 percent.

The benchmarking issues that once deterred many institutions from embracing hedge funds are slowly being swept away, thanks to new indices from Hedge Fund Research, Goldman, Sachs & Co., CSFB/ Tremont and Morgan Stanley Capital International (MSCI). With benchmark obstacles abating and equity markets continuing to whipsaw in 2001, "market-neutral" or "absolute-return" hedge funds have emerged as an option worth considering for corporate portfolios, provided the true absolute-return hedge funds - i.e., those uncorrelated to underlying markets - can be identified.

According to hedge fund advisor Hennessee Group, hedge funds have outperformed domestic stock mutual funds in 12 of the past 14 years. Institutional investors now make up roughly 25 percent of hedge fund assets, up from only 5 percent in 1993, according to Cerulli Associates. Reuters recently reported that while individuals still account for 54 percent of total hedge funds assets, "corporations now appear to be the fastest-growing source of capital."

Greenwich Associates, a research and consulting firm, notes that corporate pension funds, public funds and endowments have all increased their use of hedge funds strategies since the firm's first surveys on the topic in 1998; that growth is...