Discretionary hedge funds tend to outperform systematic funds when markets are rising, but systematic funds can provide lower volatility and higher risk-adjusted returns, according to research by Preqin.
As such, systematic funds are generally perceived as providing good downside protection to investors in down markets. Given that a recent Preqin survey of investors highlighted that the majority invest in hedge funds for uncorrelated returns, risk-adjusted returns or reduced portfolio volatility, rather than high absolute returns, systematic funds can be an attractive prospect to certain investors.
Discretionary hedge funds have outperformed systematic hedge funds over the past five years in terms of absolute returns, returning 11.56 per cent on an annualized basis compared to 7.85 per cent (as of 31 May 2014).
However, systematic hedge funds have exhibited lower volatility than discretionary hedge funds over the last five years (three to five per cent vs. six to 11 per cent).
This downside protection provided by systematic funds was highlighted in 2008 and 2011: systematic hedge funds returned -0.03 per cent and 1.81 per cent in these years respectively, compared to discretionary funds which posted -18.65 per cent and -2.83 per cent.
Relative value and macro strategies following a systematic approach outperformed their discretionary counterparts on an annualised basis over the past three years on average.
Although the level of launches of both discretionary and systematic funds fell in 2013 compared to 2012, there was a far greater drop in discretionary fund launches (138 in 2012 to 85 in 2013), compared to systematic funds (66 in 2012 to 52 in 2013).
The number of recorded systematic CTA launches dropped from a peak of 60 in 2012 to 45 in 2013, while the number of CTAs launching with a discretionary approach more than doubled from seven in 2012 to 15 in 2013.
Some 56 per cent and 46 per cent of investors seek risk-adjusted returns and reduced portfolio volatility respectively when investing in hedge funds, compared to just seven per cent that said they invest in hedge funds for high returns. 


“Discretionary funds have outperformed systematic funds in recent years in terms of absolute returns, taking advantage of the fact that markets during this period have generally been rising,” says Amy Bensted, head of hedge funds products at Preqin. “However, our research has shown that systematic hedge funds often outperform discretionary hedge funds whenever markets are falling, which was the case in 2008 and 2011, and these funds also offer benefits to investors in terms of lower volatility and superior risk-adjusted returns. Furthermore, certain systematic fund strategies have provided higher absolute returns over longer time periods compared to their discretionary counterparts.
“Establishing which type of fund is right for investors very much depends on the fund strategy, the risk profile of the investor and the general market conditions. The majority of hedge fund managers continue to use a discretionary approach while most CTAs focus on a systematic strategy, although there is some evidence in both of these cases of more fund managers adopting the alternative approach.”
