With the rapid growth of hedge funds in the last decade across the globe, there has been a strong demand for benchmarking tools by single- and multi-manager clients seeking to benchmark against a relevant index that more closely mirrors their regional and strategic mandates and by investors looking to ensure that their managers are outperforming a "bucket" of their peers. To monitor this significant expansion in the alternative fund industry, Eurekahedge launched a fully comprehensive suite of 200+ hedge fund indices with subsets based on region, country, strategy and fund size, available at www.eurekahedge.com/indices and on Bloomberg at HDGE.

Methodology - Hedge Fund Index

Mean Returns

The monthly index values are the respective mathematical means (average) of the monthly returns of all hedge fund constituents in the index at that time. Unlike other indices, they are not asset-weighted (see relevant paragraph below) nor median returns. A simple example of the differences between a mean and a median return index is as follows:

Essentially, the median return index ignores all values above and below the middle-ranked value (in this case, 4%) and in the case of a population of returns that demonstrate kurtosis will generally overestimate or underestimate the average of the population. In the example above, the true mean is 2%; however, the median returns is 4% due to this value (4%) being the middle-ranked value.

Regional Mandate

90% of the regional mandate of the fund must be in a specific region or country. For example, there are 2662¹ European funds in our database, but we have only 285² funds in the Eurekahedge European Hedge Fund Index. Many European-based funds do not exclusively allocate to Europe but have significant allocations to the US. Likewise, US-based funds that allocate exclusively to Europe will be included in this index. Essentially, head office location is irrelevant.

To further elaborate on the regional indices:

The Asian index comprises funds that allocate 90% of their strategy to Asia Pacific – the region consisting of India, Singapore, Malaysia, Indonesia, Thailand, Australia, New Zealand, China, Hong Kong, Taiwan, Korea and Japan. The broad Asian index encompasses the following component indices:

The Asia inc Japan indexcomprises funds that allocate to Asia Pacific but excludes hedge funds with pure Japan mandates. This index includes funds with partial allocations to Japan, such as an ‘Asia inc-Japan’ mandate.

The Asia ex-Japan index comprises funds that allocate to Asia Pacific but have 0% exposure to Japan, ie it excludes all funds with full or partial allocations to Japan and includes funds investing in any country or region in Asia outside of Japan.  

The Greater China index comprises funds that invest in mainland China, Hong Kong, Macau and Taiwan.

The Australia/New Zealand index comprises funds that invest in Australia and New Zealand.

Other country-specific indices comprise funds that pursue a pure single-country strategy, such as the Japan, Korea, India and Taiwan indices.

The European index comprises funds that allocate to Europe, including Iceland, Greenland, Turkey, Russia and the CIS, and South Africa.

The North American index comprises funds that allocate to the United States, Canada and Alaska.

The Latin American index comprises funds that allocate to Mexico and Central and South America.

The Emerging Markets index comprises of funds that allocate 90% of their strategy to emerging markets. Either funds that allocate to a single emerging market country, emerging market region or globally. Emerging markets are defined by Eurekahedge as developing Europe (Central and Eastern), Latin America, Russia, Asia (excluding Japan, Australia and New Zealand), the Middle East, Africa and the Caribbean.

A visual representation of these overlapping regional mandates is as follows:

Unique Funds

Only "unique" funds are selected for the index (no duplicate share classes, currency denominations, onshore and offshore versions of the same fund, series etc.). For example, if we include both sets of performance numbers for the European Absolute Return Fund-USD and the European Absolute Return Fund-EUR in our database, we would only include one set of performance numbers in the index. For arguments’ sake, we take the fund with the most assets in that class.

Equal Weighting

The indices are not asset-weighted. We simply give an overview of the average performance of hedge funds, without attempting to highlight monthly inflows and unjustly overweigh the performance of certain funds due to good marketing staff or location in investor hot spots.

Taking the above data, we can see in the table below that for a single month's returns, the difference in index values is 2.16%, depending on whether an index is weighted by the fund's asset size or not. Essentially, a weighted index like this is ignoring the performance of 70% of the funds in it due to their comparatively lower asset size.

Equal weighting also encompasses funds denominated in different currencies, such as US dollar, euro and Japanese yen. The index is purely an average of the performance of the constituent funds, irrespective of currency denomination.
 
Dead, Closed and New Funds

If we discover new funds with a historical performance history, these funds will be immediately included in the index and all returns rebalance accordingly. If a fund dies, its track record will remain permanently in the index. Furthermore, since the rationale behind our suite of indices is relative benchmarking (rather than making them investible), funds that are closed for further capital inflows are also included in an index.

Survivorship Bias

There has been an abundance of research into survivorship bias and the supposed influence on hedge fund indices.  Eurekahedge has undertaken three things to eliminate this effect:

• Eurekahedge launched the indices with an inception date of January 2000 – a year before Eurekahedge was founded and hence, we have been in a good position to monitor the attrition rate of hedge funds around the globe.
• In each of our databases, we have a separate section for "Obsolete Funds" to provide complete transparency to our subscribers on the status of the hedge fund universe since we started monitoring it.
• If we uncover a fund that died before we even included it as a live fund, we will endeavour to track down the historical returns of this fund to include it in our database and indices.

Latest Index Values

As and when we receive monthly NAV updates from the managers, these are fed immediately into our database, thus, providing the latest index performance changes on a daily basis. Every day, we analyse all the funds in our database and calculate the latest values based on the % of NAVs returned by the fund managers. This would mean that historical index values may also be altered and the index rebalanced as and when new information is captured by our database. The concept and the rationale behind this may best be illustrated by drawing a contrast between equity indices and hedge fund indices:

Equity indices are comprised of publicly listed companies that must disclose their full financial information to the market. When we look at, say, the FTSE 100, we know that this comprises the top 100 (by market cap) publicly listed companies in the UK. Hence, the FTSE 100 is 100% transparent and 100% representative of the underlying constituents.

Hedge fund indices Unlike constituent companies in equity indices, hedge funds are not obliged to present their information to anyone. Hence, having complete access to all information about hedge funds and their respective returns is nigh on impossible. Database providers like Eurekahedge strive to do the best they can. To that end, we, at Eurekahedge, are reasonably successful and employ 12 people purely to gather and maintain hedge fund data from around the globe. However, we cannot maintain 100% coverage of the industry. To that end, we could not provide an index of, say, the top 100 hedge funds by size as maybe one or two of those funds may decide not to provide us with their returns. We could start running the index with all 100 funds and then a fund may suddenly stop reporting even though it is still active and trading. Hence, hedge fund index providers cannot follow the equity index methodology. There are two ways to get around this and by extension, two types of hedge fund indices:

• Some index providers have an agreement with a set number of hedge funds to provide regular returns based on those constituents. For example, they call up 100 hedge funds, asking if they would like to be in their index and then providing them with regular performance reports. The number of constituents is set and inflexible.
• Advantage - The historical data does not change.
• Disadvantage - The indices are unrepresentative of the industry due to the inflexible nature of constituent fund inclusions.
• Other index providers include all funds that they have data on for that particular sector. If the provider discovers a new fund that has a historical track record, the index will be rebalanced and the historical index values altered accordingly.
• Advantage - The indices are as representative as they can be of the actual performance of the hedge fund industry.
• Disadvantage - The historical data changes.

We, at Eurekahedge, strongly believe that the second methodology is the most sensible way of accurately reflecting the actual performance of the hedge fund landscape; every day, we rebalance our indices to include the latest performance based on the number of constituent funds that have reported their data so far. For example, the Eurekahedge Asian Hedge Fund Index was up 1.02% in November 2009 based on 91.6% of the NAV returns as at 29 December 2009 (out of 381 constituents).

More Information

For more information on Eurekahedge indices please contact us at +1 212 308 4272 (US office) or +65 6212 0924 (Singapore office), or email us at indices@eurekahedge.com.

Footnotes