The hedge fund industry has come out fighting again against perceived underperformance.

According to figures from Chicago-based data and analysis provider Hedge Fund Research, the industry posted full-year gains of 6.2% for 2012 following a strong final three months to the year. By comparison, though, the S&P 500, the leading benchmark for the large-cap U.S. equities market, returned 16% for the same period.

“There has been some talk about how hedge funds have been disappointing in terms of returns over the past couple of years but it’s important to understand what a hedge fund does,” said Mark Parsonson, executive director of U.K.-based fund of hedge funds manager Liongate Capital Management.

“Hedge funds are looking to deliver long-term stable returns. When equities are in a significant bull market, like they have been over the last few years, with the possible exception of 2011, hedge funds should underperform because they are very disciplined at managing risk and hedging their portfolios.
 
“This can’t go on forever. Hedge funds are a more stable way of generating returns and they outperform in some environments and underperform in others. This is true over a multi-decade horizon. To expect them to outperform the S&P 500 every year is unrealistic.

“Institutional investors understand that as they are building a portfolio they want to have diversified exposures and historically hedge funds have always helped them in that goal. Should institutional investors be investing in fixed income that is going to guarantee them an almost negative real rate of return over the next five or 10 years?

“Or do they want to invest in an investment such as hedge funds that is stable but has potentially more upside than fixed income currently does? I think they understand that and this is why they have remained invested in hedge funds and are continuing to add exposure.”

Institutional investors are continuing to pile into the hedge fund space in the elusive search for alpha as they increasingly embrace the risk management and diversification that hedge funds offer. Hedge funds, too, are also developing new products that are competing with traditional, long-only asset managers.

“With the conclusion of 2012, the hedge fund industry has evolved and advanced for four years since the financial crisis in December 2008, with powerful trends continuing to define and shape the significance and influence of the hedge fund industry on financial markets, asset pricing and investors in 2013,” said Kenneth J. Heinz, president of Hedge Fund Research.

“The hedge fund industry is now larger, more sophisticated, more accessible, more global, more diversified, more transparent, more efficient and more capable of meeting the requirements of institutional and individual investors in 2013.”