Hedge Funds Deliver 'Superior' Cumulative Returns Over Long Term, says Report

The risk-return characteristics of hedge funds can be well-suited to the investment profiles and funding requirements of defined benefit pension plans, according to a quarterly report from J.P. Morgan.

The publication, J.P. Morgan Prime Brokerage Perspectives, explains how beta-sensitive pensions can use hedge funds to manage volatility over the market cycle.

It focuses on three key findings:

– Hedge funds have historically provided superior risk-adjusted returns over the long term relative to conventional asset classes;

– Hedge funds offer lower volatility than long-only managers and provide greater downside protection; and

– Hedge funds may help pensions reduce portfolio volatility over time and increase their Sharpe ratios across the market cycle, helping pension plans mitigate steep drawdowns and interruption at which their portfolios compound.

The report says that a hedge fund allocation to a hypothetical portfolio consisting of 60% equities and 40% bonds would have meaningfully increased returns from the period between 1997 to 2012. A 25% hedge fund allocation would have increased the portfolio’s annualized returns by 0.53%; adding a 50% allocation to the portfolio would have increased its annualized returns by 1.08%; and reducing the 60%/40% equities/bonds allocation to 25% of the portfolio while increasing the hedge fund allocation to 75% would have increased the portfolio’s annual returns by 1.64%. A portfolio comprised solely of hedge funds would have higher annualized returns of 2.21%.