Complete Guide To Investment Companies, Funds And REITs

AAA

Hedge Funds - Benchmarks

A very common analysis, and one that is prevalent in the mutual fund world, is to analyze relative returns versus a benchmark. For example, a large-cap manager would be compared to the S&P 500 Index and his or her performance would be evaluated based on the fund's returns and standard deviation relative to the index. For hedge funds, the relative performance analysis is more challenging, but not impossible.

Although most hedge fund marketing materials compare themselves to the S&P 500 to display their outperformance and uncorrelated returns, as investors, we have to understand if the manager is doing well relative to other hedge funds using the same or similar strategies. The first step in this process is to gain enough of an understanding of the hedge fund manager's style, in order to determine which hedge fund index, if any, their performance can be compared to.

As mentioned in the section on strategies, many strategies can be categorized into certain buckets, but each fund has a unique strategy. In many cases, some hedge funds may have multiple strategies, making the index decision more difficult. Let's evaluate a simple example:

Suppose we are evaluating a long/short equity fund that focuses on event-driven opportunities, such as mergers, management buyouts, share buybacks or any other events. There is both a long/short equity index and an event-driven index, and the obvious solution is to run a comparison to both. We could evaluate whether the hedge fund's performance is more like one index than the other. If the fund compares well versus both indexes, however, then additional due diligence is warranted. If the fund compares poorly, then the due diligence process may end there.

Once a hedge fund passes the index test, we could then get more specific in our comparisons by evaluating the hedge fund performance versus peers that use similar strategies. The first level of peer analysis would be a comparison of returns versus other hedge fund managers that state they apply the same strategy. Most databases group hedge funds into categories that are closely related to the hedge fund indexes mentioned above. However, unlike the hedge fund index, which may only have a limited number of funds, choosing all the funds in a category gives the analysis a much broader perspective and allows the analyst to place the fund in quartiles relative to peers.

Related Readings:

Standard Deviation & Value At Risk
Related Articles
  1. Mutual Funds & ETFs

    How Mutual Fund Companies Make Money

    Read about the many different kinds of fees and sales charges mutual fund companies can use to generate revenue from those who invest in their shares.
  2. Investing Basics

    The Lipper Rating System Explained

    Take a closer look at how Lipper Inc., a subsidiary of Thomson Reuters, determines the ratings for mutual funds in its Lipper Rating System.
  3. Mutual Funds & ETFs

    Top 4 Royce Funds for Retirement Diversification in 2016

    Discover four of The Royce Funds mutual funds suitable for diversifying retirement portfolios that focus on investing in small-cap companies.
  4. Mutual Funds & ETFs

    Top 3 VALIC Funds for Retirement Diversification in 2016

    Learn about the VALIC fund family, its performance relative to its peers and the top three VALIC funds to consider for retirement diversification in 2016.
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Investing Basics

    Contingent Convertible Bonds: Bumpy Ride Ahead

    European banks' CoCos are in crisis. What investors who hold these high-reward but high-risk bonds should know.
  7. Mutual Funds & ETFs

    The 4 Best T. Rowe Price Funds for Growth Investors in 2016 (TROW)

    Discover the four best mutual funds administered and managed by T. Rowe Price that specialize in investing in stocks of growth companies.
  8. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  9. Active Trading Fundamentals

    4 Stocks With Bullish Head and Shoulders Patterns for 2016 (PG, ETR)

    Discover analyses of the top four stocks with bullish head and shoulders patterns forming in 2016, and learn the prices at which they should be considered.
  10. Mutual Funds & ETFs

    Top 3 Lazard Funds for Retirement Diversification in 2016

    Learn about Lazard Asset Management, its long history of strong performance and the top three Lazard funds to consider for retirement diversification.
RELATED TERMS
  1. Green Fund

    A mutual fund or other investment vehicle that will only invest ...
  2. Alternative Energy ETF

    An exchange-traded fund that invests in companies engaged in ...
  3. PIPE Deal

    Signifying "Private Investment in Public Equity," a PIPE deal ...
  4. Collateralized Mortgage Obligation ...

    A type of mortgage-backed security in which principal repayments ...
  5. Consumer Staples

    Essential products such as food, beverages, tobacco and household ...
  6. Hedge

    Making an investment to reduce the risk of adverse price movements ...
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  3. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
  4. Do mutual funds require a demat account?

    A dematerialized account enables electronic transfer of funds. The account is used so an investor does not need to hold the ... Read Full Answer >>
  5. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  6. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center