Complete Guide To Investment Companies, Funds And REITs

AAA

Hedge Funds - Absolute Returns & The Sharpe Ratio

Absolute Returns
A hedge fund must be evaluated based on absolute returns, but those returns also need to be consistent with the fund's strategy. There are funds that employ strategies that generate very consistent returns over time with limited volatility. An example of this type of fund is an asset-backed lending fund that makes loans and collects payments that are predictable and consistent over time. These funds can generate anywhere from 8 to 12% per year and are often used as a substitute for fixed income, when fixed income is not attractive.

There are other fund strategies that should have similar returns and there are also strategies that should generate higher returns, albeit with much higher volatility. In either case, a hedge fund that describes its strategy as pursuing absolute returns should always have positive returns over 12-month periods, for example. Most hedge funds fall short of these expectations, but in a perfect world, absolute returns should be positive and consistent.


The Sharpe Ratio
One metric that is widely used in the hedge fund world is the Sharpe ratio. The Sharpe ratio measures the amount of return adjusted for each level of risk taken. It is calculated by subtracting the risk-free rate from annualized returns and dividing the result by the standard deviation of the returns. This metric can be applied across hedge funds with different levels of returns and volatility to determine whether the hedge fund is generating any alpha (excess return) by taking on additional risk. A good Sharpe ratio will vary by strategy and anything above 1 tends to be an attractive return. As with other measures, however, the following analysis should be conducted using Sharpe ratio, as well as pure returns metrics.

Related Readings:

Benchmarks

You May Also Like

Related Articles
  1. Investing in emerging market bonds might sound creative and fun, but sometimes it’s more profitable in keeping it simple and close to home.
    Mutual Funds & ETFs

    The EMB Emerging Market Bond ETF: Use ...

  2. Get Rich Slowly found about the insights on investing from about 2,000 selected individuals by an online survey. Do they have an investing strategy?
    Investing Basics

    Do You Have An Investing Strategy?

  3. The Vanguard S&P 500 ETF (VOO) offers a relatively safe investment opportunity for people who aren't sure which way the market is headed.
    Mutual Funds & ETFs

    Will Stock Market VOOdo Continue?

  4. Investing Basics

    The Most Popular Bitcoin Mining Software

  5. VelocityShares 3x Long Crude Oil ETN has the potential for huge returns, but there are several reasons why you might want to steer clear for now.
    Mutual Funds & ETFs

    A Leveraged Oil ETN For The Future (Just ...

Trading Center