When people use the term “Alternative Investments”, they generally refer to hedge funds and private equity. A hedge fund is loosely defined as a pooled vehicle which purports to deliver returns which do not follow the traditional asset classes such as stocks or bonds. Unfortunately, we saw in 2008 steep declines in stocks accompanied by steep declines in the returns of many hedge funds. In other words, the primary appeal of hedge funds – that they are truly hedge funds – was not realized by a large part of the hedge fund universe.
This experience has resulted in an ongoing debate regarding the nature of “alpha.” Some funds and commentators argue that if the S&P 500 Index was down 37% in 2008, and a hedge fund down only 22%, the fund outperformed its benchmark, thereby generating alpha. Being down 22% is mediocre performance – and we see the chaotic environment of 2008 as an outstanding opportunity to identify true “hedge” funds and true alpha. Merely beating the benchmark does not mean that a fund generates alpha. Good investors are committed to investing in hedge funds that have proven the ability to perform in down markets and 2008 performance can be a very useful tool in their toolbox.
