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ADVANTAGES
OF HEDGE FUNDS OVER MUTUAL FUNDS
Hedge funds are extremely flexible in their investment options because they use
financial instruments generally beyond the reach of mutual funds, which have SEC
regulations and disclosure requirements that largely prevent them from using
short selling, leverage, concentrated investments, and derivatives.
This flexibility, which includes use of hedging strategies to protect downside
risk, gives hedge funds the ability to best manage investment risks.
The strong results can be linked to performance incentives in addition to
investment flexibility. Unlike many mutual fund managers, hedge fund managers
are usually heavily invested in a significant portion of the funds they run and
shares the rewards as well as risks with the investors. "Incentive fees"
remunerate hedge fund managers only when returns are positive, whereas mutual
funds pay their financial managers according to the volume of assets managed,
regardless of performance. This incentive fee structure tends to attract many of
Wall Street’s best practitioners and other financial experts to the hedge fund
industry.
In the last nine years, the
number of hedge funds has risen by about 20 percent per year and the rate of
growth in hedge fund assets has been even more rapid. Currently, there are
estimated to be approximately 8350 hedge funds managing $1 trillion. While the
number and size of hedge funds are small relative to mutual funds, their growth
reflects the importance of this alternative investment category for
institutional investors and wealthy individual investors.
Hedge Funds Outperform Mutual Funds in Falling Equity Markets
|
|
S&P 500 |
VAN U.S. Hedge Fund Index |
Morningstar Average
Equity Mutual Fund |
|
1Q90 |
-3% |
2.20% |
-2.80% |
|
3Q90 |
-13.70% |
-3.70% |
-15.40% |
|
2Q91 |
-0.20% |
2.30% |
-0.90% |
|
1Q92 |
-2.50% |
5.00% |
-0.70% |
|
1Q94 |
-3.80% |
-0.80% |
-3.20% |
|
4Q94 |
-0.02% |
-1.20% |
-2.60% |
|
3Q98 |
-9.90% |
-6.10% |
-15.00% |
|
3Q99 |
-6.20% |
2.10% |
-3.20% |
|
2Q00 |
-2.70% |
0.30% |
-3.60% |
|
3Q00 |
-1.00% |
3.00% |
0.60% |
|
4Q00 |
-7.80% |
-2.40% |
-7.80% |
|
1Q01 |
-11.90% |
-1.10% |
-12.70% |
|
3Q01 |
-14.70% |
-3.80% |
-17.20% |
|
2Q02 |
-13.40% |
-1.40% |
-10.70% |
|
3Q02 |
-17.30% |
-3.60% |
-16.60% |
|
3Q04 |
-2.30% |
1.40% |
-1.70% |
|
1Q05 |
-2.59% |
.10% |
-2.20% |
|
Total |
-113.01% |
-10.30% |
-115.70% |
During the last 18 years, the S&P 500 Index has had 17 negative quarters,
totaling a negative return of 113.01%. During those negative quarters, the
average U.S. equity mutual fund had a total negative return of 115.7%, while the
average hedge fund had a total negative return of only 10.3%, displaying the
ability of hedge funds to preserve capital in falling equity markets.
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