Hedge funds versus equities - some general conclusions

A recent research report from UBS is touting hedge funds, and it does a good job of providing some useful insights that make intuitive sense. See "Hedge fund performance in the context of the current market & macroeconomic environment".

First, hedge funds will do better when equity valuations are stretched. Long equities will underperform when valuations are high, but hedges funds by being able to go both long and short can exploit extreme valuations. There will also be greater alpha contribution during periods of high valuation.

Second, hedge funds will do well when equities are range bound. Again, this makes good intuitive sense. When the overall market is moving higher, the name, hedge funds, gives you a clear reason why you will underperform in a directional market. When equities are in the left tail, hedge funds may also show negative returns, but the decline will be less.

Finally, if we are late in the equity cycle, hedge funds will do better on both an absolute and relative basis. Of course, all hedge funds are not like but for specific market situations, the added gain from alternative hedge fund investments can be large.