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Portfolio > Asset Managers

Carlyle Study Finds Flaws in Hedge Fund Index Inve

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WASHINGTON (–A recent study done by Carlyle Asset Management Group’s Jimmy Liew shows that passive hedge fund investing might provide returns but may yield too much exposure to unskilled hedge fund managers.

The paper, “Hedge Fund Index Investing Examined,” concluded that only 30% of managers can demonstrate statistically significant skill and that if a fund of funds can construct a portfolio with 70% “good” hedge fund investments the fund of funds managers can justify the incentive fees charged to investors.

Mr. Liew demonstrated, through a series of sample portfolios, that by putting money in an index portfolio, investors take on the risk of investing with managers with little or no skill. The expected benefits of increased diversification don’t seem to help, either. According to the study, those benefits quickly disappear under extreme market conditions, regardless of the nature of the index’s construction, equal or asset weighted.

Looking at the range of performance for three different manager groups, it was found that long/short equity managers had the biggest range of returns vs. the returns over the same time period of fixed-income and traditional equity managers. And it wasn’t just that there were more long/short equity managers in the sample. The research included 58 fixed-income managers, 64 equity managers and 38 long/short managers. The performance range between the top performing managers and the bottom decile performers was the greatest among long/short managers at 12.9%. At the same time, the performance range for fixed-income and equity managers was 0.98% and 6.16%, respectively.

Carlyle also found that the performance range of hedge fund managers has been increasing with time. The research group concluded that as the market becomes more efficient, the number of skilled managers who can generate incremental returns decreases. The study then asserts that if this is indeed true, allocating assets to an index may be a poor use of capital since investors are gaining exposure to a pool of unskilled managers.

Mr. Liew’s research also points out that the hedge fund index doesn’t necessarily perform that well in times of market distress, either. For example, in August, September and October of 1998, the Standard & Poor’s 500 stock index returned -14.5%, 6.4% and 8.1%, respectively. But while the equity market was recovering, some hedge funds were cumulatively down by more than 40% over the same three months.

The Carlyle Group is a hedge funds of funds manager. Carlyle Asset Management Group was formed in 2001 to explore the development of hedge fund offerings. Afsaneh Mashayekhi Beschloss, former treasurer and chief investment officer of The World Bank, was brought on board in May 2001 to lead the new group.


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