Dow Jones Indexes benchmark hedge fund performance by using trading strategies that are less risky because they do not rely on the skills of a manager, the company said on Thursday. Its director of alternative strategies and derivatives, Kevin Pilarski, told Reuters the index compiler had developed the hedge fund benchmarks to meet the needs of institutional investors such as banks and insurance firms.
"They want exposure to hedge funds but to the less risky end of the spectrum," he said at the Global Alternative Investment Management (GAIM) 2005 conference, organised by ICBI. "We only cover six strategies. The returns from these strategies are measurable and rely mainly on market factors and not on the trading choices made by a manager. Manager choice adds another element of risk."
One of the benchmarks is based on convertible bond arbitrage, in which the risk can be broken down into market factors such as credit, volatility, interest rates and the underlying stock.
Convertible bond arbitrage and the equity market neutral strategy, in which managers steer clear of making bets on stock market trends, are relative value strategies that involve buying securities seen as cheap against those seen as expensive.
"We also have benchmarks for equity market neutral, event driven, distressed and merger arbitrage" strategies, Pilarski said.
The other benchmark is based on long/short equity, in which funds buy stocks seen as cheap and sell those seen as expensive. The overall position in this strategy is normally long, meaning that managers have an exposure to stock market trends.
Dow Jones Indexes is part of business and financial news provider Dow Jones and Company. Its hedge fund benchmarks are licensed to US-based Lyra Capital Management.
Dow Jones Indexes does not have benchmarks for strategies that take directional bets on stocks, bonds, commodities or currencies such as global macro and managed futures funds because manager discretion means returns can be more variable, ie risky.
"We would find it very hard to defend those strategies," Pilarski said. "Many of our indices are used for guaranteed structured products, where the issuer has liability to return the principal."
The firm selects hedge funds for the benchmarks on the basis of their ability to represent the fundamental characteristics of a strategy and that have a good track record of profitability.
"We need to be sure they are not violating strategy definitions, so they need to be transparent," Pilarski said.
"Names of hedge funds that make up a benchmark can be found on our Web site ... Each benchmark will have six to eight hedge funds."
Selection also involves an analysis of returns. Those with low returns and high volatility are rejected, but so normally are those with high returns and low volatility.
The company sees no value in producing an overall index, because it doesn't cover all hedge fund strategies.
For this year to June 7, 2005, the indexes show that returns on strategies, net of fees, amounted to a 1.44 percent gain for merger arbitrage; a 0.80 percent gain for distressed securities; a 0.77 percent gain for event driven; a 0.57 percent gain for equity market neutral; a loss of 2.18 percent for equity long/short (US); and an 8.69 percent loss for convertible arbitrage.
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