The popular financial press has been overflowing with stories about the fall from grace of hedge funds—the former “masters of the universe”—over the past 10 years. These stories usually focus on the fact that hedge fund investors have lagged far behind the S&P 500 Index, while at the same time continuing to pay notoriously high fees. The key flaw in this argument is that the S&P 500 Index represents the broad equity market and is not an appropriate benchmark for most hedge fund strategies.

As their name suggests, hedge funds take significant hedging or short positions, and most carry substantially less market risk than equity indices. Ultimately, the success of these investment strategies can be judged by answering this question: do hedge funds generate significant positive alpha (or excess return) above and beyond their market exposure, and how much are investors paying for this alpha?

Our Approach

Because hedge fund returns are usually a mix of alpha and beta (benchmark exposure), it is crucial to measure and track the alpha component. Simply identifying the appropriate benchmark is a challenge for strategies that invest across asset classes, geographies and sectors. Measurement is further complicated because benchmark exposure varies over time.

With this in mind, SEI has developed a number of tools to measure and track manager alpha against a range of benchmarks. Armed with these tools and an experienced team, SEI’s approach is differentiated by the following investment philosophy:

• Do not be complacent: When a manager’s alpha deteriorates, we ask if this is a temporary or permanent phenomenon. Perhaps the manager’s style is temporarily out of favour and this may represent an opportunity to add. On the other hand, it may be a permanent change, resulting from loss of focus or strategy drift. In this case, we do not hesitate to cut a manager; no exceptions for reputation or (former) “masters of the universe”.
• Fish in the right ponds: We look for alpha where it is more likely to be found. Think of managers focusing on less well-covered smaller-capitalisation companies, international markets, niche strategies, or those taking advantage of new types of data.
• Pay for alpha, not beta: We are willing to pay higher fees for strategies where most of the return is derived from alpha, such as non-directional strategies. For more directional strategies, we recommend investors should insist on only paying a performance fee over a market benchmark.
• Be opportunistic (be early, or be late): We find that it is possible to structure attractive investment terms with smaller or newer managers that are highly motivated to offer better terms (be early). Conversely, if a quality manager is going through a difficult period that we believe is transitory, this is a good opportunity to add to the investment, especially on preferential terms (be late).

Our Portfolios

The results we deliver to our investors are all that matters at the end of the day. While 2018 was a difficult year for just about every asset class, our defensive offering—the SEI Opportunity Fund—posted a positive return. Our more aggressive offering—the SEI Special Situations Fund—incurred only a fraction of the market downside, and more than recovered those losses during the first quarter of 2019. It is well ahead of HFRI’s fund-of-funds indices over one, three and five years, and both funds’ risk-adjusted returns (Sharpe ratios) exceed that of the S&P 500 Index over the past three years. 

Annualised Performance as of March 31, 2019

SEI’s View

Our analysis has shown that the critics are correct in one respect: alpha generated by most hedge fund strategies has fallen since 2008. We recognise that the hedge fund industry has become more crowded and competitive in recent years, and it has become more difficult to remain differentiated and generate alpha.

SEI’s approach has not stood still. We have adapted and evolved in an effort to continue finding managers and strategies that can deliver attractive returns for our clients.

Index Definition

S&P 500 Index: The S&P 500 Index is a market-capitalisation-weighted index that consists of 500 publicly traded large U.S. companies that are considered representative of the broad U.S. stock market.












Important Information

While considerable care has been taken to ensure the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

SEI Investments (Europe) Limited acts as distributor of collective investment schemes which are authorised in Ireland pursuant to the UCITS regulations and which are collectively referred to as the “SEI Funds” in these materials. These umbrella funds are incorporated in Ireland as limited liability investment companies and are managed by SEI Investments Global, Limited, an affiliate of the distributor. SEI Investments (Europe) Limited utilises the SEI Funds in its asset management programme to create asset allocation strategies for its clients. Any reference in this document to any SEI Funds should not be construed as a recommendation to buy or sell these securities or to engage in any related investment management services. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application must be made solely on the basis of the information contained in the Prospectus (which includes a schedule of fees and charges and maximum commission available). Commissions and incentives may be paid and if so, would be included in the overall costs.) A copy of the Prospectus can be obtained by contacting your SEI Relationship Manager or by using the contact details shown below.

The SEI Special Situations Fund and SEI Offshore Opportunity Fund II are non-EEA Alternative Investment Funds managed by SEI Investments Management Corporation (SIMC). These SEI Alternative Investment Funds are non-standardised and bespoke, and usually invest in a variety of underlying assets such as shares, debt securities, commodities or mutual funds. Alternative Investment Funds by their nature involve a substantial degree of risk, including the risk of complete loss of capital and are only appropriate for parties who can bear that high degree of risk and the highly illiquid nature of an investment. SEI Alternative Investment Funds often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, are not required to provide periodic pricing or valuation information to investors, involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements and mutual funds, and often charge higher fees.

Data refers to past performance. Past performance is not a reliable indicator of future results. Investments in SEI Funds are generally medium- to long-term investments. The value of an investment and any income from it can go down as well as up. Returns may increase or decrease as a result of currency fluctuations. Investors may get back less than the original amount invested. SEI Funds may use derivative instruments which may be used for hedging purposes and/or investment purposes. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events.

In addition to the usual risks associated with investing, the following risks may apply: Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. International investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments, securities focusing on a single country, and investments in smaller companies typically exhibit higher volatility.

The opinions and views within this commentary are of SEI only and are subject to change. They should not be construed as investment advice.This information is issued by SEI Investments (Europe) Limited (“SIEL”) 1st Floor, Alphabeta, 14-18 Finsbury Square, London EC2A 1BR, United Kingdom. SIEL is authorised and regulated by the Financial Conduct Authority.
SEI sources data directly from Factset, Lipper, and BlackRock unless otherwise stated.