Despite begin caught with their hands in the beta cookie jar last quarter, hedge funds had one of the best relative performances ever in Q3 – beating equity indices by a country mile.  Most industry participants acknowledge that various “alternative betas” and even, as we have recently seen, traditional betas have found their way into hedge fund returns.  And some now attribute hedge funds’ returns since 2003 as simply repackaging beta and selling it at alpha prices.  While countless reports of abysmal hedge fund performance have included the caveat that they have still beaten the S&P 500 handily this year, the industry remains in the cross hairs of the mainstream media for what it alleges was “promising absolute returns in good times and bad”.

Despite the marketing power of the “absolute return” moniker, its adoption by the hedge fund industry is now coming back to haunt it.  Although we know very few hedge funds naive enough to make such promises, the tacit endorsement of the term by the industry at large has obscured the benefits of old-fashioned relative performance.

Institutional investors have largely adopted hedge funds not because of their performance, but because of their diversification properties – as indicated by their low market correlation.

A survey conducted last year by French business school Edhec shows that virtually all performance measures used by European institutional investors are essentially relative, not absolute.

More…