Do Hedge Funds Outperform Stocks and Bonds?

Abstract

Hedge funds' extensive use of derivatives, short-selling, and leverage and their dynamic trading strategies create significant non-normalities in their return distributions. Hence, the traditional performance measures fail to provide an accurate characterization of the relative strength of hedge fund portfolios. This paper uses the utility-based nonparametric approach of Levy and Leshno (2002) and the utility-based parametric measure of Goetzmann, Ingersoll, Spiegel, and Welch (2007) to determine which hedge fund strategies outperform the U.S. equity and/or bond markets. The results from the realized and simulated return distributions indicate that the Long/Short Equity Hedge and Emerging Markets hedge fund strategies outperform the U.S. equity market, and the Long/Short Equity Hedge, Multi-strategy, Managed Futures, and Global Macro hedge fund strategies dominate the U.S. Treasury market.