Tuesday, February 6, 2018

Is the market suffering from a definition problem for "hedge fund-like returns"?

The most thought-provoking comment I have heard in some time was "What does it mean to have hedge fund-like returns?". If a manager comes into you office and says, "I will give you hedge fund-like returns", should I be pleased or concerned? 

The statement has little or no meaning. The comment "absolute return" manager also has little meaning other than the manager will try not to lose money. What about risk-adjusted returns, does this have meaning? A good risk-adjusted return is where I get paid more return than the risk I may take-on. For many, producing a two to one return to risk ratio is a very high threshold. Most produce return to risk ratios that are lower than one.

Is there a good answer to these general questions? No. Returns have to be measured relative to their beta, risk-adjusted benchmarks. Simply put, can a hedge fund generate higher risk-adjusted returns relative to holding a market benchmark? Is there alpha with the hedge fund manager against an appropriate traditional investment alternative? The alternative should be better than a traditional choice after accounting for risk. Hedge fund managers should clearly address this issue for investors by being precise on what they expect to deliver to investors.

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