Hedge Fund Returns After Market Stresses

Here is a look at periods of adversity in the hedge fund industry when declines exceeded -5% as measured by the HFRI Fund Weighted Composite Index.  The period covered is 1990 through the present.  From 1990 to 2007, the HFRI Fund Weighted Composite Index has had four periods when the peak-to-trough drawdown exceeded -5%.

Year Decline
1991 -5.38%
1998 -11.42%
2000 -6.39%
2002 -5.71%
Average -7.23%

In the 6-, 12-, 24- and 36-month periods following the drawdown, average performance was:

  6-MO 12-MO 24-MO 36-MO
Average Return 8.40% 18.66% 36.06% 56.16%
Average Annualized 17.51% 18.66% 16.64% 16.02%

This data reveals considerable opportunity after periods of significant adversity.  While drawdowns of greater than -5% to -10% are relatively rare in the hedge fund industry, they have now occurred five times in 18 years -- or approximately every three to four years.  These periods have historically been followed by above-average performance as financial instrument mispricings return to historical ranges. 

Where are we now? 

As of August 31, 2008, the HFRI FWC Index was in a -6.45% drawdown that began last November.  The best intra-month estimate for September is an additional -4.91% decline (as measured by the HFRX Global Hedge Fund Index as of 9/18), which results in an estimated -11.36% drawdown.  This is nearly identical to the 1998 decline at the time of the Long Term Capital Management crisis.

Current AffairsSteven Karsh