Mirroring the growth of the hedge fund industry, hedge fund indexing has taken off in recent years, driven by investor demand for transparent benchmarks and the index providers' recognition that trusted indexes can, if carefully constructed and marketed, attract their own assets.
By one count as many as 17 separate hedge fund indexes now claim to track the performance of the hedge fund universe. Although these indexes purport to be measuring the same industry, they occasionally vary so widely that getting a handle on what the numbers actually mean can leave investors scratching their heads. Take May and June, for example. Composite returns for five indexes–the Van Global Hedge Fund Index, the Credit Suisse First Boston/Tremont Hedge Fund Index, the Hennessee Group hedge fund index, the MSCI hedge fund index, and the Standard & Poor's hedge fund index–were within 70 basis points of each other for June.
A month earlier, though, the variation between those same five indexes was 130 basis points. The variations in returns extended below the composite and into the substrategy returns.
The differences highlight what a report from the Edhec Business School in Nice, France, calls "the challenge of representativity." In other words, you can say you have an index, but its value depends on how well it represents the performance of the industry as a whole. The limitations to representativity begin with the number of funds on which the index is based–which according to Edhec ranges from a claim of 3,100 by HedgeFund.net to 41 by S&P–and extend to include the notable fact that the hedge funds comprising the indexes report their performance voluntarily.
Yet for all their discrepancies in returns, construction, size, and inclusiveness, the indexes themselves seem to have been accepted for what they are: a series of benchmarks that, collectively, can be used to measure the relative performance of absolute return strategies. Additionally, investors, particularly institutional investors like pension funds, love index investing.
That's one reason why assets linked to the four largest hedge fund index providers–CSFB/Tremont, MSCI, S&P, and Chicago-based Hedge Fund Research Inc.–totaled about $10.5 billion as of March. By one estimate, total assets linked to investable hedge fund indexes as of March ranged from $11.5 billion to $12 billion, up from between $8 billion to $10 billion eight months earlier.
