Hedge funds shifting to benchmark performance

By Laurence Fletcher

LONDON (Reuters) - Investors are pushing hedge funds toward the use of relative rather than absolute measures of performance, which could create pressure on fees, hedge fund industry figures said.

Hedge funds, which can use tools such as derivatives and short-selling to help protect assets and make money when markets are falling, have tended to measure their performance in absolute or real returns.

In contrast, traditional fund managers tend to measure performance against benchmarks and against rival funds, though some are beginning to adopt absolute measures of performance.

However, speakers at the Reuters Hedge Funds and Private Equity Summit in London this week said there was investor pressure on hedge funds to look at benchmark measures of performance.

"Hedge funds hate benchmarks. They try to demonstrate that what they're trying to achieve is alpha, not beta," said Nicholas Roe, managing director for European equity finance at Citigroup.

"(But) investors' habit is to push toward relative performance. Unfortunately, it's the way of the world; people love to have something to compare performance with."

Beta returns track stock or bond market trends, while alpha measures returns regardless of market movements.

Nils Tuchschmid, head of multi-manager portfolios at Credit Suisse (CSGN.VX: Quote, Profile, Research, Stock Buzz), said it was pension funds -- of which U.S. schemes have tended to invest more in hedge funds than UK counterparts -- that are applying the pressure.

Hedge fund managers don't measure performance against benchmarks, he said.

"(But) with pension funds, the natural tendency is to think about benchmarks. They (hedge funds) are starting to compete with classic long-only benchmarks. This is potentially a danger for the industry."

Last month Patrick Armstrong, a fund manager at Britain's Insight Investment, told Reuters he was "very worried" by anecdotal evidence that hedge funds were increasingly focusing on relative performance and beta rather than absolute returns.

Armstrong recently sold his hedge fund positions and instead bought long-only funds and put options to try and replicate the performance of hedge funds whilst paying lower fees.

FEE PRESSURE

Some hedge funds, having performed well in the bear market at the start of the decade, have sought to continue their performance record by riding the bull market in stocks over the last three years.

However, this has led to the charge from some commentators that they were "beta jockeys", rather than generators of alpha, but still charging high fees.  Continued...