Last week two completely different stories caught my eye. The first was the news that a flurry of pension schemes are selling down their allocations to hedge funds, citing cost and performance. The second story was the release of the annual league table of super brands, including iconic businesses such as British Airways, Apple and Coca-Cola. It struck me that hedge funds could do with a brand refresh.
 
Despite their compelling long-term track record, the perception of hedge funds is that they are built around high fees, millionaires, Ferrari-driving fund managers and average performance, particularly during and after the financial crisis.
 
High fees and poor performance are not a compelling proposition. However, hedge funds have actually made significant progress with the former. A recent analysis by the hedge funds team at our firm, Aberdeen Asset Management, indicated that the average management fees are closer to 1.6% across the industry. The historic "2 and 20" model -- a 2% annual fee and a 20% performance fee -- is a thing of the past; only managers with a consistent track record are able to levy it.
 
But treating hedge funds as one broad category is overly simplistic, and not at all helpful. The differences among them result in a large dispersion of returns, both across and within hedge fund strategies. It is here that we start to get to the nub of the issue: Investors must understand the characteristics of different fund strategies and distinguish the "quality" of the fund, the "quality" of the returns and the opportunity set within each strategy. And then they must know when to invest in them.
 
We looked at the question of hedge fund fees and in November 2013 published a paper for investment professionals, entitled “Hedge Fund Fees -- Does It Pay To Pay?” where we explored these issues in much greater detail. For investors seeking access to higher beta strategies, the report said, cheaper opportunities clearly existed in the long-only space. However, if an investor seeks absolute, uncorrelated and low beta sources of returns, then, on average, hedge funds charging higher fees produce better-quality returns than their lower-fee counterparts. What was also clear, though, is that within the higher fee bracket, there was a wide dispersion of returns, bringing the importance of manager selection to the fore.
 
In practice, this is far easier said than done, so investors often focus their attention on more tangible factors such as cost and performance. The dangers here are manifold. First, one should consider the diversification benefits that a strategy can offer. Strategies that are less sensitive to traditional asset classes could be viewed as higher quality by exhibiting a lower correlation with major indices. The next thing to consider is the quality of the return. If a fund can offer strong risk-adjusted returns, this also can bring significant benefits to an investor.
 
Hedge funds need to address the poor image they have. One thing they can do is be more transparent about their fees. But hedge fund managers also need to articulate better the diversification benefits and risk-adjusted returns their products offer if they want to see bigger allocations from pension schemes and remain relevant.
 
Andrew McCaffery is global head of alternatives at Aberdeen Asset Management.