Investment Strategies of Hedge Funds

16

Hedge Fund Performance Analysis

Performance analysis must always be associated with risk analysis, because every performance is connected to the assumption of some risks.

16.1 RISKS INHERENT IN HEDGE FUND INVESTMENTS

Risk management is an extremely important activity for the success of a hedge fund. In order to survive in highly volatile markets, stock picking skills are no longer a sustainable competitive advantage for the fund manager. This skill must be accompanied by a welldesigned and rigorously managed risk management system.

The risks associated with the strategies adopted by hedge funds are more complex than those entailed in traditional investments. In order to appreciate the actual risk a subscriber of these funds may run, it is necessary to carry out an in-depth analysis of the peculiarities of the investment strategy and of the risk management techniques adopted by the fund. There are basically three types of risks:

• market risk;

• credit risk;

• liquidity risk.

Figure 16.1 highlights the overlapping areas of these three risk classes in a hedge fund investment.

Market risks are associated with the performance of the variables affecting capital markets (prices of financial instruments, interest rates, exchange rates, etc.). The possible use of leverage magnifies the market risks to which a hedge fund is exposed. Depending on the investing style, the fund manager has the possibility of acting so as to reduce this risk.

Credit risk is associated with the reliability ...