Do Hedge Funds Hedge?

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Abstract
Many hedge funds claim to provide significant diversification for traditional portfolios, besides attractive returns. The authors provide empirical evidence regarding the return and diversification benefits of hedge fund investing using the CSFB/Tremont hedge fund indexes over 1994–2000. Like many others, they find that simple regressions of monthly hedge fund excess returns on monthly S&P 500 excess returns seem to support the claims about the benefits of hedge funds. The regressions show only modest market exposure and positive added value. This type of analysis can produce misleading results, however. Many hedge funds hold, to various degrees and combinations, illiquid exchange–traded securities or difficult–to–price over–the–counter securities. For the purposes of monthly reporting, hedge funds often price these securities using either the last available traded prices or estimates of current market prices. These practices can lead to reported monthly hedge fund returns that are not perfectly synchrono...

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