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Hedge Fund Characteristics and Analysis July 16, 2007

Posted by federalist in Finance.
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Today’s readings in the industry literature turned up some salient research with important results:

Brown, Goetzmann, and Liang conclude that it is improper to buy a Fund of Funds that only layers fees (typically 1%-and-10%).  In that structure an investor can end up paying incentive fees even when he loses money!  But it does make sense to both an investor and a FoF to pay a 28% incentive fee if the FoF absorbs the sub-fund incentive fees and charges the investor only on the overall performance of their portfolio.

Harry Kat suggests that “there’s no free lunch” in hedge funds — i.e., that hedge funds are not trivially beneficial diversifiers in an efficient-portfolio sense.  More practically, he demonstrates that it is not fair to compare investments based on Sharpe ratio only, but rather that we must also consider the skewness of their returns when making a comparison.

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1. federalist - September 5, 2012

From a broad and interesting survey by Peter Thiel:

The difference between a [proper] hedge fund and a “hedge fund” is this: a hedge fund seeks to allocate capital from less efficient uses to more efficient uses; a “hedge fund” seeks trading strategies. Mostly, “hedge funds” merely seek to replicate successful strategies of the past until they don’t work.

2. federalist - August 6, 2014

From an excellent discourse on risk parity by Antti Ilmanen and Cliff Asness:

When most investors think about “alternatives,” hedge funds, private equity and various other illiquid investments come first to mind. However, these investments tend to offer more equity market exposure than desired in truly alternative returns. The correlation of both major hedge fund indexes and private equity indexes with global equity markets exceeded 0.8 in the past decade.

Although hedge fund marketing is all about alpha, a drill-down into the industry track record suggests that hedge funds deliver a combination of an embarrassing amount of market risk premia (simply being long stock market risk), alternative risk premia and some alpha — not so much, but by many measures at least positive.


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