Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Industry Characteristics

Over the past 20 years, the absolute performance of the industry has significantly expanded investor wealth and the wealth of those directly and indirectly engaged in the hedge fund business.

According to data compiled by HFR, $1,000 invested in the stock market in 1990 would be worth just under $6,000 at the end of 2011, whereas the same money invested in hedge funds would be worth more than $10,000. In addition, the annualized volatility of a diversified basket of hedge funds would be significantly less than the stock market. In fact, at 6.52, it would be less than half the almost 16 percent volatility experienced by the stock market over that period.

In addition to absolute return, the performance of the industry is often measured by its Sharpe ratio. This ratio measures the relationship between risk and reward above the risk-free rate during the period. The Sharpe ratio of the industry as a whole is very attractive relative to other asset classes. It is significantly better than investing in stocks alone. Most individual hedge fund strategies have a better Sharpe ratio than the S&P 500.

Over the past 20 years, strategy allocations have moved from purely global macro during the early years to a mix of global macro, event, and long and short equity today.

Global macro strategies include a broad range of strategies in which the investment process is predicated on movements of economic variables and the impact these movements are predicted to have on equity, ...