Liquid Alternative Mutual Funds versus Hedge Funds: Returns, Risk Factors, and Diversification

Abstract

Despite the rapid rise of the number of liquid alternative mutual funds (LAMFs) available to retail investors in recent years, few studies have compared how their returns, risk, and other characteristics (fees, turnover, and assets) differ from their hedge fund counterparts across their entire history. Being one of the first comprehensive studies to analyze more than two decades of LAMF performance, this article compares the performance of LAMFs to hedge funds, both in aggregate and broken down by investment styles and performance quintiles. Overall, LAMFs underperform hedge funds on average by 1% to 2% per year on a net-of-fee basis when controlling for standard risk factors. These findings provide important implications for investors seeking liquid hedge fund–like returns as well as for policymakers who have recently proposed imposing derivative position limits on 1940 Act investment vehicles. TOPICS: Mutual funds/passive investing/indexing, real assets/alternative investments/private equity, performance measurement, legal/regulatory/public policy