Chapter 4 - A dynamic trading approach to performance evaluation

Abstract

This chapter summarizes dynamic trading strategies as a tool for performance evaluation. Dynamic trading strategies do not make any assumptions about fund return distributions; it can be applied to funds with normal as well as non-normal return distributions. The test appears to be unbiased, while with 120 observations sampling error risk does not seem to be prohibitively high. On a stand-alone basis, it is found that 12 of the 13 indices to be inefficient, with the average efficiency loss amounting to 3%. The hedge fund indices score much better when seen as part of an investment portfolio though. Due to their weak relationship with the index, seven of the 12 hedge fund indices classified as inefficient on a stand-alone basis are capable of producing an efficient payoff profile when mixed with the S&P 500. The best results are obtained when around 20% of the portfolio value is invested in hedge funds.