Alternative Investments: Risk and Returns - Dissertation Example

Hedge funds have recently gained popularity and acceptance by institutional investors for diversifying traditional stock and bond portfolios. This alternative asset class traditionally has low correlations with stock and bond markets and offers protection in turbulent markets (Amenc et al., in press). Much recent debate has centered on how to measure and evaluate the performance of hedge funds, therefore comparing hedge funds to standard market indices could be erroneous since hedge funds possess different characteristics than traditional stock and bond funds.

In the literature, we frequently observe hedge fund rankings displayed using measures such as the Sharpe ratio, but this could pose problems due to the option-like returns that hedge funds generate (Fung and Hsieh, 1997). The importance and key role hedge funds play by using leverage, short selling, and other derivatives strategies could have an influencing effect on portfolio management by providing downside protection. Nevertheless, the inclusion of hedge funds in investor portfolios further requires more accurate methodologies to handle the asymmetrical returns they produce.

Particularly, since hedge fund manager selection is a precise process for appraising both risk and reward. The term “hedge fund” was first introduced in the US in 1949 by Albert Winslow Jones (Fung and Hsieh, 19997). From 1975 onwards, the hedge fund industry experienced a dramatic increase in terms of the number of funds as well as total managed assets. In the late 1990s, US researchers started to pay attention to hedge funds and hedge fund performance related issues.