After being beaten up along with most hedge fund strategies in 2008, emerging markets hedge funds are roaring back this year along with the fortunes of their target regions.  Hedge Funds Review reports that,  "While prone to volatility, emerging markets hedge funds have historically posted strong gains following market bottoms. In the 12   months following the trough of each of the five largest performance declines, funds have produced an average gain of 23.3%."

And Citigroup recently told Bloomberg News, "There is going to be an outsized investment back into Asia. Some of the big pensions are going to be looking at Asia; it's coming onto the radar screens."

We wondered if this was just a matter of emerging markets beta, or whether emerging markets hedge funds provide added value? For a perspective on this, we turned to our resident emerging markets expert, Peter Douglas, CAIA, Principal, GFIA pte ltd.

For long-term investors, hedge funds are the most prudent approach to access the opportunities inherent in emerging markets.

Emerging market equity investing has typically been characterized by dramatic price movements through market cycles in both directions.  In addition, the inefficient, diverse and often rapidly developing nature of emerging capital markets creates challenges which can create unexpected risks for non-specialist investors.

In a recent report, GFIA analyzed how hedge funds specializing in emerging market investing can both exploit these market inefficiencies, and protect themselves from extremes of price movements, thereby generating stronger risk adjusted returns over time.  The paper further evaluates the performance of emerging markets hedge funds against traditional investment methods, including long only funds, using various metrics. The key conclusions of the study are:

• On a risk adjusted basis (whether risk is measured as volatility or drawdown), emerging market hedge fund aggregates have performed better than both the broader emerging market equity indices, and developed market indices.
• Emerging market hedge funds have relatively low correlation with developed market asset classes for most time periods in the last 8 years.
• Adding emerging market hedge funds to traditional portfolios creates powerful diversification benefits which can expand portfolios' efficient frontiers.
• During periods of falling markets, hedge funds exhibit lower drawdowns than their underlying markets. This in turn enables them to recover more swiftly when markets return to an upward trend, providing more powerful compounding than unhedged investing.
• Finally, a terminal wealth study of hedge fund returns versus mutual fund returns demonstrates that, over holding periods of both 5 years and 3 years, terminal wealth from portfolios of hedge funds is superior to that from mutual funds, regardless of starting year of investment.
  
  Click here to read more.