Do Hedge Funds Need to Outperform the Market?

Hedge funds, and those who manage them, have been under relentless media attack for the past 5 years for failing to outperform the market. But, outperforming the market may not be the principal objective institutional investors and high net worth individuals (HNW) expect from an investment in hedge funds.

If That Were True

Alternative investing is on the rise and hedge funds are garnering a significant share of these investment dollars. McKinsey & Co. predicts that alternative investments will generate forty percent of the asset management industry’s global revenue by 2020. Alternative investments totaled $7.2 trillion at the close of 2013 and hedge funds had a twenty-seven percent share, with $2 trillion under management, which ballooned to $3 trillion at the close of 2014.

Logically, if outperforming selected market indices, such as the S&P 500, were the investors’ bellwether, hedge fund growth would be in negative territory given its decidedly lackluster performance compared to the market during the past 5 years.

Why Do Hedge Funds Continue to Thrive?

No single response  adequately answers this question, but contrary to what many would suggest, HNW individuals and institutional investors are not drawn to hedge funds because of an allure to the exotic, or because investors are like sheep, or because of sundry non-quantifiable reasons offered in defense of hedge fund investment. A number of factors contribute to the continued growth the hedge fund industry enjoys but, the most defensible reason hedge funds thrive, is that they provide respectable risk-adjusted returns.

Simply put, the safety of a hedge fund investment, relative to its rate of return, is acceptable to a high percentage of institutional and HNW investors. Such investors are not looking to the S&P 500 as a benchmark, but rather to Treasury bill rates, bond rates and rates of return on similar investments that are deemed extremely low risk. For these investors, capital preservation is the paramount consideration and returns are secondary.

In short, the typical hedge fund investor seeks maximum return at minimal risk. Those responsible for investing pension funds, college endowments and family fortunes lack the stomach for market volatility and, their fiduciary responsibilities place them in conflict with high risk investment options. Respectable risk-adjusted returns are a commodity that hedge funds have consistently delivered for decades and for this reason, hedge funds continue to thrive.

Does This Bode Well for Jobs?

While there is no proven methodology for estimating staffing requirements for incremental increases in hedge fund assets under management, a conservative estimate suggests that one additional staff member is required for each $125 million increase in assets. If hedge funds experience year-over-year growth in a range similar to the $1 trillion increase from 2013 to 2014, the future looks bright for hedge fund jobs.

If the McKinsey & Co. predictions are to be believed, those with an entrepreneurial spirit might consider creating their own job by starting their own hedge fund. The growth in the hedge fund industry is undeniable. If you possess the right skill set, there may be no better time to make the leap!

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