Q. So this is the Hedge Fund Research Institute, one of the leading providers of hedge fund performance indices, right?
A. Yes, one of several: Barclay’s, Credit Suisse, and others are also popular. All of them are taking performance reports from the several thousands of hedge funds out there and creating averages… overall, and strategy specific. But the HFRI seems to be the one most often in the news stories that begin “Hedge funds once again failed to keep up with the stock market”…

Q. And I know that’s one of your pet peeves! But why do you think that’s not a fair way of talking about hedge fund returns?
A. There are two big reasons. The first is that the news stories use the indices that blend radically different kinds of hedge fund strategies into a single number. Global macro, equity long/short, credit arbitrage… It’s like a sports announcer starting a broadcast with “our local football, basketball, and hockey teams were all in action tonight, and their average score was 22”.

Q. So your point is that doesn’t make sense to average such fundamentally different kinds of investments into a single statistic.
A. That’s half of it. The other half is what we talked about today with Charles Stucke: performance dispersion. The best alternatives managers do maybe 10X better than the worst ones. It’s a huge difference, and so an average does not represent what an investor can expect. That, of course, also goes to the question of what you should pay managers, and why some may be worth 2/20, but many are not.

Q. But isn’t the same true when you’re talking stock market performance?
A. Not really. The difference between the best and worst stock fund managers is only around 2X– especially since indexing became so widespread, the gap is pretty narrow. And they’re all pursuing the same types of assets with the same strategy– long only. So whereas it might be fair to refer to an average stock picker, it is absolutely silly to refer to an average hedge fund manager.