New Hedge Fund Classifications Would Promote Transparency and Boost Investor Confidence, According to Bank of New York Mellon St
October 22 2007 - 8:30AM
PR Newswire (US)
Report spotlights common myths regarding hedge fund volatility,
alpha- generation and risk LONDON, Oct. 22 /PRNewswire-FirstCall/
-- The convergence between hedge fund and equity market returns,
combined with inconsistencies in hedge fund classification, could
cause widespread confusion on how such funds should be used to
diversify investment portfolios and result in unrealistic return
expectations for investors, according to a study conducted by The
Bank of New York Mellon and independent research firm Oxford
Metrica. The report, entitled Rethinking performance in the hedge
fund industry, recommends that hedge funds be classified using
cluster analysis instead of the traditional classification by
strategy. Cluster analysis groups funds according to the observed
behaviour in their returns, as opposed to management styles.
Traditional hedge fund indices are challenged by increasing demands
to demonstrate transparency of the underlying funds and many hedge
funds may change their strategy to maximise alpha. The resulting
style drift is the cause of much difficulty in benchmarking and
investor understanding. In classifying 5,282 hedge funds, the study
found that: -- Stable clusters perform better - some investors may
wish to invest only in funds whose performance does not fluctuate
greatly, or that represent a larger class of funds -- Outliers are
loners that can do well or very poorly - some investors will be
happy to take the risk of a unique fund but Amaranth is an example
of one which went wrong -- Drifters are lack-lustre - funds that
drift from one cluster to another tend to underperform David
Aldrich, managing director, The Bank of New York Mellon, said: "The
recent volatility in the equity markets was a real stress test for
the hedge fund industry and should be seen as a springboard for new
industry efforts to increase overall investor confidence and to
manage return expectations. Increased transparency of the
underlying funds, and the use of cluster analysis for fund
classification, will help identify a fund's true investment
strategy and highlight any style drift, which collectively will
improve investor confidence." Dr. Rory Knight, principal of Oxford
Metrica, said: "Cluster analysis adds a time dimension to the
classification of hedge funds and thereby allows a robust means of
evaluating any drift in style over time. A major issue for the
industry as a whole is to manage risk, return and correlation -
alpha will need to be proven to justify the fee structure." The
study removes three common myths surrounding hedge funds: -- Hedge
Fund Myth #1: All hedge fund returns exhibit high volatility. The
analysis reported shows that most categories of style and strategy,
on average, are less volatile than the equity markets. -- Hedge
Fund Myth #2: All hedge funds generate pure Alpha. Despite the
ubiquity of the "absolute return" epithet in the industry, hedge
fund returns are increasingly systematic or beta driven. -- Hedge
Fund Myth #3: All hedge funds contribute little marginal risk to a
core equity portfolio. As hedge fund and equity returns converge
these vehicles are less effective diversification media. This paper
is the fourth is a series of thought leadership papers published by
The Bank of New York Mellon addressing key issues facing the
alternative investment management industry, including
"Institutional Demand for Hedge Funds" and "Hedge Fund Operational
Risk: meeting the demand for higher transparency and best
practice". The Bank of New York Mellon The Bank of New York Mellon
Corporation is a global financial services company focused on
helping clients manage and service their financial assets,
operating in 37 countries and serving more than 100 markets. The
company is a leading provider of financial services for
institutions, corporations and high-net-worth individuals,
providing superior asset management and wealth management, asset
servicing, issuer services, clearing services and treasury services
through a worldwide client-focused team. It has more than $20
trillion in assets under custody and administration, more than $1.1
trillion in assets under management and services $11 trillion in
outstanding debt. Additional information is available at
bnymellon.com. Oxford Metrica Oxford Metrica is an independent
research and analytics firm in international investments. The firm
focuses on risk, value, reputation and governance - the strategic
aspects of financial performance. Oxford Metrica aims to provide
evidence-based support for key management decisions. Oxford Metrica
also provides research and analytics to several hedge fund managers
particularly those involving emerging markets and multi-manager
strategies. Additional information on the firm is available at
http://www.oxfordmetrica.com/. DATASOURCE: The Bank of New York
Mellon Corporation CONTACT: Kevin Heine, +1-212-635-1590, , Jamie
Brookes, +44-207-163-2146, , both of The Bank of New York Mellon
Corporation Web site: http://www.bnymellon.com/
http://www.oxfordmetrica.com/
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