Evaluating Hedge Fund Performance

PART Three

Evaluating Performance and Risks

Now that a portfolio of hedge funds has been assembled, the investors will need to periodically review, evaluate, and assess the performances of the funds in the portfolio, including their rates of return, volatility of these returns, and how these investment results were produced. The purpose, in a nutshell, is to make sure that the portfolio and its hedge funds perform as expected. The issues related to monitoring and evaluating hedge fund performances are discussed in this Part Three.

In traditional investing, risk management is an afterthought if any thought is given to it at all; the focus is on beating market indexes, not managing risks. In contrast, risk management can make or break a hedge fund. It can be said that hedge funds begin where long-only managers leave off: Hedge funds are about managing the systematic risk of the market and managing the risks of the long and short positions, not only picking the best stocks. Long-only equity managers accept the risk of the market as a given and little attempt is made to manage it. A great many long-only managers proclaim that they do not time the market and that they are always fully invested even as the market declines. Furthermore, by holding a large basket of stocks, these managers actually diversify away the risks and potential returns specific to the individual stocks, and depend on the fortune of a rising market to generate returns. No wonder the majority of mutual funds cannot ...