Hedge Fund Performance

The attractiveness of hedge funds comes from their supposed ability to produce consistent returns regardless of the performance of the broader financial market, usually with low levels of risk. Hedge funds generally utilize active management strategies, and therefore charge significant fees. These fees must be taken into account when analyzing hedge fund performance as they ultimately detract from the total return for the investor. As hedge fund assets have swelled to about $2.13 trillion and more investors continue to flock to hedge funds in such an uncertain investment environment, hedge fund performance has become a topic of much study and debate (Hedge Fund Performance, P.3).

In order to properly assess any single hedge fund’s performance, it is important to first choose an appropriate benchmark. While comparing a hedge fund’s performance to a broad market index such as the S&P 500 can be useful in terms of overall performance, it can be misleading in terms of accounting for risk-adjusted returns as hedge funds often offer significantly lower volatility. Also, hedge funds engage in a variety of different strategies, including short-biased, event-driven, market-timing, arbitrage, etc. so it would not make sense to, for example, compare a short-biased fund against a benchmark like the S&P 500 which is long-equities. It is similarly important to examine the performance of hedge funds in both bull and bear markets in order to get a complete picture of performance. Due to lower levels of volatility, hedge funds often beat the market during downturns and lag the market during upturns (Hedge Fund Performance, P.4). Lastly, there are a variety of factors that go into evaluating a hedge fund’s performance. Oftentimes, the Fama French Factor Model is utilized in order to separate out the factors that result in the total return of the fund. For example, Craig French and Damian Ko use the following equation to represent hedge fund performance:

rp = αp +...