Lyxor White Paper: Hedge Funds Could Return 5-6% in Annual Excess Return

Jul 7 2015 | 3:23pm ET

A new white paper from Lyxor Asset Management estimates hedge funds could deliver annual returns of 5-6% above the 3-month LIBOR rate, with low volatility.

The twelfth annual edition of the white paper studied the key drivers of hedge fund performance under three potential long-term macroeconomic scenarios: Normalization of U.S. interest rate policy, faster tightening of policy than expected, and secular stagnation. 

Analyzed over a five-year horizon, the three scenarios have different implications for U.S. equity markets and bond yields, noted the report. Several scenarios for market developments and their influence on hedge fund returns were modeled, and Lyxor found the second scenario, in which the Fed tightens faster than expected by the market, would boost hedge fund returns the most. 

Conversely, a scenario in which the U.S. economy would face secular stagnation, leading to continued monetary easing, would be the least supportive.

Lyxor also looked at the lack of hedge fund outperformance in 2014, noting that while the long-term track record of hedge funds is outstanding, returns delivered since the financial crisis have been disappointing. 

The report finds that the collapse in volatility and yield were possibly the main culprits last year, as volatility neared all-time lows and curtailed the ability to generate alpha and global yields sunk to unprecedented levels. Hedge funds have therefore only partially benefitted from the asset reflation that has unfolded since the financial crisis.

“Valuations are stretched in most classes, the economic cycle is maturing, and Fed policy is about to normalize,” notes the report. “As a result, the alpha environment has improved, while that of traditional asset management is getting more challenging.”

Lyxor concludes with the belief that diversifying portfolios with an increased allocation to alternatives is particularly attractive at this stage of the cycle. “Hedge funds have demonstrated their ability to protect portfolios against wide market fluctuations,” the report writes, “A scenario that can’t be excluded when the Fed turns the screw.”

The full report is available here.


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