Risk and returns of hedge funds investment strategies

This paper examines the risk and return performance of hedge fund investment strategies. Specifically, the authors examine the characteristics of the twelve main investment strategies commonly employed by hedge funds, and measure their risk exposures and risk-adjusted returns. The article finds that on average, hedge fund returns have relatively low correlations with the market and thus investments in hedge funds could potentially offer better opportunities for diversification. Using the Carhart (1997) multi-factor asset-pricing model, the authors estimate the alphas and betas of the twelve hedge fund investment strategies. It is found that each of these twelve investment strategies seem to produce on average positive and statistically significant alphas which measure abnormal returns in excess of what would be predicted by an equilibrium model such as the CAPM and a multi-factor asset-pricing model. In addition, the structure for management fee and incentive fee for each investment strategy does not seem to be in line with the level of positive alphas that a particular strategy is expected to produce. Overall, over our study period, these hedge fund investment strategies have low beta exposure, and are more likely to generate higher Sharpe ratios and positive alphas.