Complete Guide To Investment Companies, Funds And REITs

AAA

Hedge Funds - Downside Capture, Drawdown And Leverage

Downside Capture
In relation to hedge funds, and in particular those that claim absolute return objectives, the measure of downside capture can indicate how correlated a fund is to a market, when the market declines. The lower the downside capture, the better the fund preserves wealth during market downturns. This metric is figured by calculating the cumulative return of the fund for each month that the market/benchmark was down and dividing it by the cumulative return of the market/benchmark in the same time frame. Perfect correlation with the market will equate to a 100% downside capture and typically is only possible when comparing the benchmark to itself.

Drawdown
Another measure of a fund's risk is maximum drawdown. Maximum drawdown measures the percentage drop in cumulative return from a previously reached high. This metric is good for identifying funds that preserve wealth by minimizing drawdowns throughout up/down cycles, and gives an analyst a good indication of the possible losses that this fund can experience at any given point in time. Months to recover, on the other hand, gives a good indication of how quickly a fund can recuperate losses. Take the case where a hedge fund has a maximum drawdown of 4%, for example. If it took three months to reach that maximum drawdown, as investors, we would want to know if the returns could be recovered in three months or less. In some cases where the drawdown was sharp, it should take longer to recover. The key is to understand the speed and depth of a drawdown with the time it takes to recover these losses. Do they make sense given the strategy?

Leverage
Leverage is a measure that often gets overlooked, yet is one of the main reasons why hedge funds incur huge losses. As leverage increases, any negative effect in returns gets magnified and causes the fund to sell assets at steep discounts to cover margin calls. Leverage has been the primary reason why hedge funds like LTCM and Amaranth have gone out of business. Each of these funds may have had huge losses due to the investments made, but chances are these funds could have survived had it not been for the impact of leverage and the effect it had on the liquidation process.

Qualitative Factors
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares KBW Bank

    Consider an examination and analysis of the PowerShares KBW Bank Portfolio ETF, considered one of the primary financial sector ETFs.
  2. Chart Advisor

    3 Ways to Trade the Rising Volatility

    With volatility increasing in the markets, many are turning to these three volatility-capturing exchange-traded products.
  3. Term

    Understanding Total Returns

    Total return measures the rate of return earned from an investment over a period of time.
  4. Term

    What is a Prime Brokerage?

    A prime brokerage offers special services to certain clients.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares US Basic Materials

    Learn about the iShares US Basic Materials exchange-traded fund, which invests in the equities of chemicals, metals and industrial gas companies.
  6. Mutual Funds & ETFs

    ETF Analysis: Ultra Oil & Gas

    Find out more about the ProShares Ultra Oil & Gas exchange-traded fund, the characteristics of the ETF and the suitability and recommendations for the fund.
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  9. Mutual Funds & ETFs

    5 Mutual Funds that Hold Berkshire Hathaway Stock

    Discover the top five mutual funds most heavily weighted with Berkshire Hathaway stock, and the percentage of their assets dedicated to BRK.
  10. Mutual Funds & ETFs

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Real Estate Investment Trust - ...

    A REIT is a type of security that invests in real estate through ...
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  5. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  6. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
RELATED FAQS
  1. Can mutual funds outperform savings accounts?

    A mutual fund can – and should – outperform a savings account. In most cases, it should not even be a close race. Savings ... Read Full Answer >>
  2. Can mutual funds invest in private companies?

    Mutual funds can invest in private companies, which may come as a surprise to many investors. It is rare for a fund to have ... Read Full Answer >>
  3. Where do penny stocks trade?

    Generally, penny stocks are traded through the use of the Over the Counter Bulletin Board (OTCBB) and through pink sheets. ... Read Full Answer >>
  4. Where can I buy penny stocks?

    Some penny stocks, those using the definition of trading for less than $5 per share, are traded on regular exchanges such ... Read Full Answer >>
  5. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!