EUROPE - Hedge funds have significantly outperformed traditional asset classes such as equities, bonds and commodities over the past 17 years, according to a new study.

Figures from the Centre for Hedge Fund Research at Imperial College in London show that hedge funds returned an average 9.07% after fees between 1994 and 2011, compared with 7.18% for global stocks, 6.25% for global bonds and 7.27% for global commodities.

Furthermore, hedge funds achieved these returns with much lower risk volatility as measured by Value-at-Risk (VaR) than either stocks or commodities. Their volatility and VaR were similar to bonds.

'The Value of the Hedge Fund Industry to Investors, Markets and the Broader Economy' was commissioned by KPMG and the Alternative Investment Management Association (AIMA).

Rob Mirsky, head of hedge funds at KPMG in the UK, said: "Pension funds have plenty of shortfalls and very few places to obtain market-beating returns.

"There are misconceptions that hedge funds don't deliver a return. But they do provide superior risk-adjusted returns and adding them to portfolios can increase performance and reduce total risk."

The performance data for the report was obtained from a unique aggregate hedge fund and benchmark index database, representing an aggregation of current information about hedge fund performance globally.

Because both active and inactive funds are included, survivorship bias is not a factor.

The research showed that the equal-weighted portfolio policy in hedge funds, global stocks and bonds outperformed a conventional portfolio that invested 60% in equities and 40% in bonds.

Returns on the hedge fund portfolio also yielded a significantly higher Sharpe ratio with lower tail risk, or the risk of extreme fluctuation.

And an equal-weighted hedge fund index returned five times the initial investment after fees between 1994 and 2011.

The research also showed hedge funds were significant generators of alpha, creating an average 4.19% per year from 1994 to 2011.

And investors received approximately 72% of all investment profits, compared with 28% for hedge fund managers, over the 17-year period.

The survey also examined the correlations between individual hedge fund strategies and the main asset classes.

The overall findings indicate that the correlation of hedge fund strategies with the main asset classes differs significantly depending on the strategy, suggesting some strategies may be particularly attractive during the macroeconomic cycle.

The report says: "Market neutral, CTA and macro typically have the lowest correlation with global stocks during adverse macroeconomic conditions, implying that they may provide diversification benefits."

And there may be benefits at macroeconomic level as well, it suggests.

"Correlations between hedge funds and main asset classes are only slightly higher during recessions," it says. "This suggests hedge funds are unlikely to threaten the stability of the financial system."

The report argues that hedge funds are important liquidity providers in markets where they are active, and that hedge fund activity has beneficial effects for price discovery, efficient allocation of capital, financial stability, shareholder value, diversification and the broader economy.

A further report on the impact of regulation and of increased institutional allocation on the hedge fund industry will be published in a month's time.