Understanding Your Hedge Funds Performance

Understanding Your Hedge Funds Performance

So you’ve decided to invest your money in a hedge fund. Hedge funds are an attractive alternative for investing, but how do you decide which hedge fund will provide the best return on your investment? They all promise guaranteed returns with attractive numbers, but how can you understand exactly what they’re selling you? Unless you’re a finance major, you can’t! This article will explain some terms all hedge funds use and break down a hedge funds performance so you can understand exactly what they’re promoting.

Absolute Returns

An absolute return is a guaranteed percentage of return on your investment. There are different types of hedge funds with different absolute returns. Some employ strategies to remain very consistent over time, and can offer a relatively high absolute return. Others may have a low absolute return, as they are a little riskier with their investments. This may seem off-putting but the upside of a riskier investment is a higher payout and they may yield a higher return than a safer investment strategy. The choice is dependent on your investing strategy. If you are looking for a long term, consistent investment, then choose a high absolute return, with consistent, positive returns over time. Before choosing a hedge fund based on absolute returns, make sure they’ve always produced positive returns over 12 month periods. If they’ve fallen short of their predictions but are still positive, they are a safe investment. If they’ve been negative, it is riskier, as they may lose money on your investment.

Benchmarks

A common analysis which compares hedge fund performance with other types of investments. Usually when a hedge fund mentions a benchmark, they are comparing their return to that of a S&P Fortune 500 company. Comparing what you would make with their hedge fund to what your return would have been investing with that company. This can be a little misleading at times, as other hedge fund managers may have the same strategies. What would be more informative is how one manager is doing against the competition, other hedge fund managers. Most hedge funds will advertise their rate of returns versus the competition. The important thing to keep in mind is who they are comparing to. Create your own benchmarks analysis by comparing different mutual funds.

Quartile Chart

A quartile chart analyzes funds with comparable strategies. This is an effective way of narrowing down your choice of hedge fund within a certain strategy. This gives a great idea of how a singular hedge fund compares to their strategic competition. A quartile chart can compare a number of metrics, determined by you or your financial advisor. You are looking for a hedge fund that consistently performs well across all parameters. You may also set up your data to compare long and short term success. A successful hedge fund manager will consistently outperform his/her peers over many parameters including time. A quartile chart will let you take a closer look at the success of a hedge fund and it will help make an investing choice all the easier.

Business meeting.

The Sharpe Ratio

The Sharpe Ratio is a commonly used metric which determines rate of returns by the amount of risk incurred. By subtracting risk-free rates from annualized returns and then dividing by the standard deviation of those returns, you have the Sharpe Ratio. This is useful because it can be used to discover added levels of return by companies taking on risk. The Sharpe Ratio varies by strategy but any ratio greater than 1 is an exciting return. It is important to understand a hedge fund Sharpe Ratio because then you get an idea of how well their risks are usually rewarded. If a company invests more often and has a low Absolute Return but a high Sharpe Ratio, it can mean they make more frequent, riskier trades, but they are more often rewarded for them than lost.

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