Hedge funds play an increasingly
important role in institutional
portfolios as an alternative to
investments in traditional asset
classes. Yet, the minimal disclosure requirements
hedge funds face, coupled with an
investment mandate that typically allows the
use of leverage, short selling, derivatives and
highly illiquid securities, present serious challenges
for investors. How should they assess
the risk–return characteristics of a certain
hedge fund strategy in the context of their
overall asset allocation? How should the lefttail
risk of a strategy with a relatively short
return history be measured? What approach
should be used in comparing the performance
of individual hedge funds within the same
style?
This article addresses these issues through
the use of Return-based Style Analysis. This
technique, used primarily for analyzing mutual
funds, provides a way of identifying the assetmix
style of a manager and comparing it with
the asset-mix style of a specified performance
benchmark.