The Sharpe Ratio: Capital Asset Pricing Model

The Sharpe Ratio is a common metric used to measure the mean return per unit of risk in a hedge fund investment strategy. It measures the excess returns over the risk free rate and divides this excess return by the portfolio’s risk, which is also its standard deviation.

This metric is applicable across hedge funds with different investment strategies. Generally speaking, a hedge fund portfolio with a Sharpe Ratio of 1 and above tends to generate attractive returns. Additionally, the Sharpe Ratio can be used to determine if a hedge fund is generating excess returns over what was predicted using the Capital Asset Pricing Model (CAPM). This excess return can be measured using alpha where an alpha of 1.0 indicates that the fund has outperformed

Notably, results with a positive skewness indicate a higher probability of returns being lower than the mean but there is a limit to the amount of losses and vice versa. Hedge funds with a positive kurtosis are characterized by a distribution indicating a higher probability around the mean, representing consistency in the hedge fund’s performance over the years.

5.3 Maximum Drawdown and Calmar Ratio

Maximum Drawdown measures the most recent percentage decline from the fund’s highest net asset value (peak) to its immediate lowest net asset value (trough). This metric is used to identify an investment’s financial risk. A variation of the Maximum Drawdown is the Calmar Ratio, which is derived by dividing the compounded returns of the fund over the peak to trough drawdown in the similar period.

Trends in Hedge Funds Industry

6.1 Great Alpha: Decreased Correlations, Higher

Consequently, these managers’ assets inflate past the optimal asset level required to maximize returns for their investors given the risk level. Additionally, as the asset gets inflated, it becomes increasingly difficult for managers to add value through security selection. Since management fees (2% of total assets) are now a substantial amount, managers increasingly choose to reduce the risk of their portfolio and thus the optimal returns level as they are more interested in maintaining the assets on hand rather than maximizing returns and risk losing both the management fees and commissions on returns should they make losses when taking additional