Hedge Fund Returns - a Challenge for Reporting

In contrast to mutual funds, hedge funds employ dynamic investment strategies and enjoy a high degree of freedom with regard to the instruments that they can hold in their portfolio. To that can be added the possibility of engaging in short selling of securities and using leverage. Consequently, alternative strategies are infinitely more complex than those of traditional funds.

The sophisticated investment strategies of hedge funds have considerable consequences for their return structure. In essence, hedge fund returns differ from those of mutual funds in three respects. First, hedge funds returns are – as opposed to mutual fund returns – not normally distributed. Second, they are non-linear with respect to the standard market factors, such as those of equity and bond markets. Finally, hedge funds often modify their investment style so that their exposure to risk factors is highly dynamic over time.

All these differences are very important when it comes to the detailed analysis of hedge fund returns, as required by adequate and comprehensive hedge fund reporting. Most important, many studies have highlighted the weaknesses of traditional mutual fund risk and performance indicators for evaluating hedge funds. Hence, it is essential for any good hedge fund reporting to employ performance and risk indicators that are appropriate and thus reliable.

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