July 19, 2010

Three Studies Worth a Quick Read

Recent research from Vanguard, American Century and Fund Quest looks at hedge funds and diversification, risk management, and the debate over active vs. passive management.

Do hedge funds hedge? The experience of the Great Recession - Vanguard Research

Do hedge funds help investors avoid the worst during periods of distress in the financial markets? The recent Great Recession provides an opportunity to explore the experience of hedge fund investors during just such a time.

In this paper, Vanguard looks at funds of hedge funds, as well as at several categories of specific types of hedge funds.

It finds that hedge funds served to insulate investors to some degree from the extreme stock market crash, but that most of the hedge fund categories failed to provide significant diversification beyond that of a 60/40 portfolio of stocks and bonds.

Getting off the Sidelines: Investing in the Smart Risk Zone - American Century Investments

Individual investors have experienced painful losses in recent years. Some have left the financial markets; others are reluctant to recommit their assets.

Financial advisors -- who know there is a correlation between risk and reward -- want to get their clients off the sidelines, out of cash alternatives, and back on track toward achieving their financial goals.

American Century Investments recommends that investors pursue a smart-risk strategy. Smart risk takers seek to identify, understand, and manage risk by focusing on investment vehicles that offer higher potential return, lower volatility, better downside protection, and consistent compensation for risk.

What Now: Active or Passive Management? Examining Real Alpha and Exotic Beta -FundQuest

Actively managed stock funds saw net cash outflows of $221.8 billion in 2008, while passively managed index funds enjoyed net cash inflows of $17.6 billion, according to data from Lipper Inc.

Significantly, U.S.-based exchange traded funds (ETFs) experienced roughly $178 billion in net inflows for the same year. Over 20% of total stock fund assets were allocated to passive index funds or ETFs at the end of 2008, according to the Investment Company Institute.

Active managers still represent the majority of market assets. But passive investments have been gaining market share over the past few years.

The never-ending debate between the merits of active and passive management has become even more relevant to investors today: What approach will provide investors with vital benefits from a long-term perspective? When the recovery eventually comes and the markets bounce back, which investment approach is likely to do better?

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