Traditional and Alternative Risk: Application to Hedge Fund Returns

Claudio Boido,Antonio Fasano

doi:10.5817/fai2016-1-1

Abstract

This study compares the risk-adjusted performance of traditional and alternative investments. Instrumental to this design, we introduce a specific metric for assessing hedge fund performance, comprising both the relative advantage and the extra-risk of an alternative investment over a traditional one. We are concerned with the impact of the crisis. Common wisdom tells us that during phases of market euphoria, investors’ wishful thinking can make them overconfident of the high returns promised by the leveraged structures and the aggressive investment policies typical of this asset class; conversely, when the downturns hit, the “big bets”, taken by hedge fund managers, in risky and illiquid investments, can trigger severe losses in their investors’ portfolios. We found evidence that regime switches in stock returns emphasise the performance gap among the different fund investment policies; furthermore, some styles can effectively capitalise on managerial skill, outperforming traditional equity investment in terms of adjusted performance.

Highlights

A hedge fund is an investment that offers risk and return opportunities not obtained with any other asset class
The explanation lies in the fact that the performance of each strategy is based on the exposure to the asset classes traded on the different markets, that is, when there is a market crisis, the same crisis is reflected in hedge fund returns
As regards risk measures and risk-adjusted performances, we built two specific measures representing the risk premia involved in alternative investments:

Summary

Introduction

A hedge fund is an investment that offers risk and return opportunities not obtained with any other asset class. Each hedge fund follows a different strategy in terms of risk/return. The explanation lies in the fact that the performance of each strategy is based on the exposure to the asset classes traded on the different markets, that is, when there is a market crisis, the same crisis is reflected in hedge fund returns. Hedge funds would purchase bank debt or high yield corporate bonds of companies undergoing re-organization (often referred to as ’distressed securities’) They do the opposite if the deal is likely to fail

Methods

Results

Conclusion