Evaluating Hedge Fund Performance

PART One

A Primer on Hedge Funds

Though separated by some 70 years, the crash of 1929 and the bubble burst of 2000 shared some similarities. In the five years between the low in May 1924 and the monthly high in August 1929, the Dow Jones Industrial Average, which represented the stocks of the companies of America's fast-growing industrial economy, had risen by 31.8 percent a year. Half a century later, the NASDAQ was the index that captured the imagination of the investing public with its constituent stocks of the companies in the computer, Internet, and information technology sectors. It, too, had risen by an average of 32.8 percent annually during the nearly six years prior to the burst, from the monthly low in June 1994, which had been brought on by the Federal Reserve's aggressive raising of interest rates, to the high in February 2000. The subsequent decline in the NASDAQ was only marginally less severe, 78 percent as compared to 88 percent in the 1929 crash, and lasted almost as long, 31 months versus 34 months starting in 1929.

No one knows how long it will take the NASDAQ to recover to the preburst level of 5,132, although after a year-end rally in 2004 it has gained some 95 percent from the bottom in 2002. However, we do know that two years after the bottom in July 1932, the Dow Jones Industrial Average had risen by 136 percent, and yet it took more than 25 years for the Dow to re- cover to the precrash level. Twenty-five years is a long time to wait, even for patient ...