Evaluating Hedge Fund Performance

CHAPTER 6

Picking the Winners

There are some 7,000 hedge funds in operation as of latest estimates, more than the number of companies listed on the New York Stock Exchange and the NASDAQ combined. And new ones are being formed every day. This sheer size of the hedge fund population dwarfs even the most resourceful and largest of investors. So, how do investors learn about managers? How do they evaluate them and pick out the winners? The answer to the first question is it's done the old-fashioned way: from someone they know. To answer the second question, they get to know the managers.

SOURCING HEDGE FUNDS

It used to be that the population of hedge funds was much smaller, and the information about them as well as access to them were limited. So, wealthy investors relied on their contacts to source hedge fund managers.

Today, funds of hedge funds still claim that they have a competitive edge because of their vast network of contacts in Wall Street. This is not an empty boast. Funds of funds and other institutional investors experienced in hedge fund investing have accumulated databases of hedge funds over time, containing details about individual funds' strategies, track records, and portfolio managers, and hosts of other information, much of which is not available in commercial databases. They also maintain a smaller “buy” list of funds that have met their investment criteria whose track records they follow closely on a regular basis and whose lead portfolio managers they have become ...