Amanda Cantrell at CNN/Money reviews hedge fund performance for the first three quarters of the year and examines the potential for fourth quarter returns. Hedge fund indices have generally outperformed the equity indices. Some specialized hedge funds, notably emerging market funds, have significantly outperformed.

Some market factors have kept returns down, like the lack of volatility. Structural factors may also be at play:

Some of the decline in returns has to do with the fact that, as more and more players crowd into the $1 trillion industry, certain strategies that were once profitable have simply become too crowded. There is only so much “alpha,” or excess return, that can be squeezed out of the market, which is why industry veterans call the search for alpha a zero-sum game.

One factor not mentioned in the article is the effect that rising short term interest rates has on hedge funds. Hedge funds that sell securities short are going to get an ongoing boost from higher interest rates. How? Hedge funds earn a return, tied to short term interest rates, on the funds generated by short sales. This “short interest rebate” will rise with higher interest rates. While not a skill-based return, this short interest rebate will have a material effect on many hedge funds.

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