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Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance by Kevin R. Mirabile

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Exposure to Specific Adverse Price Movements or Historical Scenarios

In addition to evaluating historical data, investors should want to know the specific impact of adverse price changes on the current portfolio. This can be accomplished by asking the manager or a third-party service provider to mark the portfolio to a set of prices related to a specific change in rates, spreads, or indices or to changes that occurred during a specific historical event. This approach gives the investor information that is prospective in nature and reflects the sensitivities of the current portfolio rather than having to rely on normality assumptions or past performance to estimate future returns. Sometimes managers report on portfolio sensitivity to specific changes in interest rates, credit spreads, or stocks in isolation and as part of a specific historical scenario. Sensitivity to a .1, 10, or 100 basis point change in interest rates or credit spreads or a 5, 10, or 20 percent change in the value of the S&P 500 are commonly used to measure fund sensitivities.

Fixed-income funds usually disclose their portfolios’ duration, convexity, and credit spread sensitivity. Equity-oriented funds report on their beta exposures to the S&P 500.

Duration is one of the most important measurements to consider in evaluating a bond or a bond portfolio. Duration is simply the measurement of the sensitivity of the price of a fixed-income portfolio to a change in interest rates. This measure can help predict the ...

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