Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Ho-hum hedge returns no problem for some investors

What lesson can you learn from Hedge Funds?

Hedge funds have gotten a lot of bad publicity over the past few years for underperforming broad market gauges, but most institutional investors couldn't care less.

In fact, they prefer funds that focus less on eye-popping returns and more on generating steady, achievable growth levels and portfolio diversification, according to a survey released this week by Preqin, an information provider for the alternative investment industry.

That's important at a time when the stock market index is coming off a year in which it posted gains in excess of 30 percent, while hedge funds as a whole rose a comparatively modest 8.9 percent net of fees.

"It doesn't surprise me," Anthony Scaramucci, founder and co-managing partner of SkyBridge Capital, said of the survey results. "In the search to make actuarial goals, institutional investors and high net-worth investors are looking for high single-digit, low double-digit returns that can be generated with less volatility than the overall market and certainly less volatility than the S&P 500."

The survey numbers at least on their face are fairly startling.

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Despite lagging broader market performance, hedge funds either met or exceeded expectations from 84 percent of the investors Preqin surveyed. What's more, 95 percent said the funds either met or topped their investment objectives over 12-month, three-year and five-year periods.

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Those numbers come as at least something of a surprise to Uri Landesman, head of Platinum Partners hedge fund, who divides his clients into two classes with two very different expectations from their investments.

"You need to distinguish between people who know what they're investing in and don't know what they're investing in," he said. "My educated clients have been very pleased with their results, because we delivered exactly what we said, which is fairly consistent returns regardless of the market environment. My less-sophisticated investors take a look at a (32) percent in the S&P 500 and say, 'why don't I get that?'"

The $2.94 trillion hedge fund industry faces a variety of problems, most of them stemming from perception or the image it has garnered over the past several years.

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At their core, though, hedge funds are supposed to be, well, hedges. Their intent is to be a shield from market dangers and provide assets and returns that actually are not correlated to the rest of the market.

Another problem has come with the go-go image they cultivated around the time of the financial crisis. Many had bet big on subprime mortgages and lost, while those who bet against—John Paulson and a handful of others—made enormous profits and raised expectations that they were some type of get-rich-quick investment scheme.

"People like us are not taking beta bets on markets but rather taking alpha bets on individual investments, which hopefully are exogenous from what's going on in the broader market," Landesman said.

Retail investors involved on the hedge side probably need to learn some lessons yet, but the larger institutional clients seem to be on board.

According to the Preqin survey, 87 percent of institutional hedge fund investors say they will be increasing their allocations in the next year, during which total industry assets almost surely will surge past $3 trillion.

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That sentiment comes as funds as a whole have returned just 2.3 percent net of fees in 2014, according to eVestment. The S&P 500 had returned just under 5 percent by then and has continued to climb.

Yet survey respondents said that's another unfair way to look at hedge fund investing—other measures besides the S&P 500 should be used to gauge performance.

"Our findings also demonstrate that the frequent, broad comparisons of hedge fund performance to standard market indices, such as the S&P 500, are generally viewed as irrelevant by the institutions making the investments and judging their success, as these indices do not reflect the diversity of the hedge fund industry or its risk/return characteristics," Amy Bensted, head of hedge fund products at Preqin, said in a statement.

Overall, 19 percent of investors said the S&P 500 is their most commonly used benchmark to measure performance, but a larger number—24 percent—said it and other such indexes "are no longer relevant" ways to gauge effectiveness.

—By CNBC's Jeff Cox

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