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Alternative Market Briefing

Other Voices: Misconception of hedge funds

Thursday, July 21, 2016

This article was authored by Logica Capital Advisers, Los Angeles.

Investors use hedge funds (HFs) for a variety of reasons, including diversification and improved risk adjusted returns. However, our observation has shown that HFs carry some misconceptions about their benefits. We have listed a few of these misconceptions which are extracted from our larger study, The Misconception of Hedge Funds.

MISCONCEPTIONS OF HEDGE FUNDS:

- The vast majority of HFs produce returns with negative skewness which directly increases the probability of severe drawdowns. More so, negative skewness most often comes alongside excess positive kurtosis, which in combination, further exacerbates the magnitude of the drawdown.

- Evidence suggests that HFs are not properly hedged, and as such, are too highly correlated to equity markets and do not exhibit regime independence. Even worse, for the HF category that purports to be the most hedged, e.g. market neutral, evidence highlights that they are often not neutral beyond directionality (beta). . HFs overly rely upon momentum in constructing portfolios, which is partly why HF returns are negatively skewed and suffer when momentum is out of favor. . HFs are typically long biased, and therefore, have a hard time producing when stocks decline.

- HFs do not produce honest alpha, but most often, risk premia/beta dressed up as alpha. Accordingly, the returns of most HFs can be replicated with common ......................

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