![]() ![]() What that also means is they don’t have the same amount of risk as investing purely in the stock market.įor some funds, there is no easily producible and representative benchmark, particularly in the case of funds that often go short, use derivatives, and other complex products. For many funds, that relative amount of stocks exposure might be 50% or even less. The relative amount of stock or equity exposure in this proxy is related to how much the fund in question invests in equities, over a long time period. ![]() Bonds generally have less risk than stocks so the overall benchmark is typically less risky than one made up purely of stocks. The most realistic benchmark may be a correspondingly complex mixture of assets and investable instruments, but a more easily calculated proxy is a mixture of stocks and bonds. ![]() They invest in a variety of instruments, including complex instruments like derivatives. The problem with comparing against an equity index is that hedge funds do not typically allocate all of their capital to equities. The obvious question that arises next is what benchmark should be used? The benchmark in the chart above is simply the market returns, so in the US market this is the S&P 500. Obtaining a completed due diligence questionnaire from the fund manager should cover some of the points above, although a series of meetings is also required to get the information needed.Īlpha measures the outperformance of a given hedge fund against a selected benchmark. Fees – What fees does the fund manager charge and is it appropriate for the type of fund / type of investor / performance characteristics.Operations – A sign of a more mature and investible firm is a robust operational infrastructure.Risk management – A key issue in fund management, monitoring and controlling risk of trading positions as well as portfolio leverage allows for more control over potential drawdown events.Team – How long has the team been managing money? Is there key man risk?.Investment philosophy and approach – How are investment decisions made? Who makes the decisions? Which markets, assets, techniques are used as part of this process?.Hedge fund performance or alpha, is covered in the next section. Investment results – Performance, stability, length of track record, and measured using how much assets under management.Going into some more detail as to the typical points that need to be covered, and the specific questions that need to be answered: Liquidity – the ability to rebalance the portfolio effectively around different events, for example redemptions, losses, and so on.Control – control over the strategy in terms of operations as well as its risk of creating drawdowns.Consistency – how consistently does the strategy delivers positive returns, and how likely is it to continue doing so in the future.Stability – the potential for those returns to fluctuate over time.Profitability – the manager’s ability to generate returns.Our own internal framework is structured around these key points: What helps here is having a well thought out, consistent, framework to follow. There are multiple stages or parts here, covering the investment process, approach, team, track record, and operational aspects also. It’s still worth going through it as it highlights some of the considerations in choosing fund managers. It’s also a process that individual investors do not typically follow – it applies more to larger, institutional investors or family offices. This is a key part of the process, and one which potentially takes the most time. ![]()
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