AN EVALUATION OF HEDGE FUNDS: RISK, RETURN AND PITFALLS

Francis Koh (), David K. C. Lee () and Kok Fai Phoon ()
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Francis Koh: School of Business, Singapore Management University, Singapore
David K. C. Lee: Ferrell Asset Management, Singapore
Kok Fai Phoon: Ferrell Asset Management, Singapore

The Singapore Economic Review (SER), 2002, vol. 47, issue 01, 153-171

Abstract: Hedge funds are collective investment vehicles fast becoming popular with high net worth individuals as well as institutional investors. These are funds that are often established with a special legal status that allows their investment managers a free hand to use derivatives, short sell and exploit leverage to raise returns and cushion risk. Given that they have substantial latitude to invest, it is instructive to examine the performance of hedge funds as compared to other forms of managed funds. This paper provides an overview of hedge funds and discusses their empirical risk and return profiles. It also poses some concerns regarding the empirical measurements. Given the complexity of hedge fund investments, meaningful analytical methods are required to provide greater risk transparency and performance reporting. Hedge fund performance is also beset by a number of practical issues generating "practical risks". These risks are not fully addressed by the usual risk-adjusted performance measures in the literature. A penalty function to discount these extraneous risk dimensions is proposed. The paper concludes that further empirical work is required to provide informative statistics about the risk and return of hedge funds.

Keywords: Hedge funds; Risk management; Performance measurement; Nonnormal distribution; Hurst Ratio; Risk penalty function (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1142/S0217590802000493

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