Chapter 26 – Hedge Funds
CHAPTER TWENTY-SIX
HEDGE FUNDS
CHAPTER OVERVIEW
This chapter discusses the various hedge fund strategies devoting a great deal of attention to market-
LEARNING OBJECTIVES
After studying this chapter, the student should have a thorough understanding of the characteristics of hedge
PRESENTATION OF MATERIAL
26.1 Hedge Funds versus Mutual Funds
Like a mutual fund, a hedge fund is an investment pool; however, there are important differences. Hedge
26.2 Hedge Fund Strategies
Hedge funds may include directional strategies, which is a bet that one sector or another will outperform
other sectors of the market. Nondirectional strategies are usually designed to exploit temporary
26.3 Portable Alpha
An investor may feel that a stock is relatively underpriced and that the market is about to fall. Even
Chapter 26 – Hedge Funds
26-2
26.4 Style Analysis for Hedge Funds
Although many hedge funds pursue market-neutral strategies, many pursue directional strategies. This
26.5 Performance Measurement for Hedge Funds
Hedge funds as a group seem to have performed quite well exhibiting large and positive alphas with
Sharpe ratios that are consistently higher than that of the S&P 500. This could be due to skilled hedge
fund managers or to factors which make evaluating hedge fund performance difficult. For example,
hedge funds tend to hold more illiquid assets than other institutional investors meaning that it is important
26.6 Fee Structure in Hedge Funds
The typical hedge fund fee structure is a management fee of 1% to 2% of assets plus an incentive fee
equal to 20% of investment profits beyond a stipulated benchmark performance, annually. These