We analyse the evolution of the hedge fund industry and try to assess whether this alternative investment class makes sense over the traditional one. We are concerned with the impact of the crisis. Common sense tells us that that during phases of market euphoria, possibly due to over-optimism, investors may be attracted by potentially high returns promised by the leveraged structures and the aggressive investment policies of this class of funds. When the downturns hit, managerial opacity heightened by lack of regulations, scarce liquidity and level of risks (supposedly) higher than market portfolio can trigger severe losses in investors’ portfolios. Thereupon, we tested empirically whether bear markets have a stronger impact on performances of these funds when compared with traditional investment classes and, dealing in terms of relative performances and losses, our results do not always comply with the common wisdom. Instrumental to this we introduce a specific metric for assessing hedge fund performance, comprising both the relative the advantage and risk of the alternative investment over the traditional one.


Part I

1. Introduction

A hedge fund is an investment that offers risk and return opportunities not easily obtained with any other asset class. A hedge fund is an alternative asset class, where asset managers disclose only the main outlines of their strategy without going into technical details so as to keep their potential profits. If the financial markets are not efficient, active managers are able to beat markets to make a profit from their strategy. Each hedge fund follows a different strategy in terms of risk/return. These strategies reflect on the individual manager’s skill and the performances are not linked to the benchmarks as mutual funds. The heavy use of leverage can have a potential effect on expected returns in terms of volatility even if in some strategies, as market neutral, the volatility tends to be lower. Therefore hedge fund returns combine a manager’s skill and the features of the selected strategy which have shown a strong correlation with equity markets than other over the year. Most investors classify hedge funds as alternative assets even if, during the fall of financial markets of 2008, the correlation between hedge fund indexes and equity indexes was approximately 0.82, that is the hedge fund strategies had a bad impact on the financial crisis as well as on traditional asset classes. The explanation lies in the fact that the performance of each strategy is based on the exposure to the asset classes traded on the different markets, that is, when there is a market crisis, the same crisis is reflected on hedge fund returns. Billio et al. (2010) noted that there was an apparent interconnectedness among hedge funds,banks, brokers, and insurance companies during the financial crisis of 2007-2009, which amplified shocks into systemic events. Their results suggested that while hedge funds can provide early indications of market dislocations, they may not give significant contri- butions to systemic risk as those of banks, insurance companies and brokers. According to Eureka hedge publications, the assets managed by the hedge fund industry declined by $470 billion between June 2008 and April 2009. Fortu- nately, the flight of investors from the hedge fund industry stopped in May 2009, when inflows into the hedge fund industry exceeded outflows for the first time since June 2008. Given the shock experienced by the industry in 2008, it is certainly interesting to understand if …