10 Things That Investors Should Know About Hedge Funds

Abstract

In this article, the author reviews some of the most important findings in hedge fund research so far. We show that proper hedge fund investing requires a much more elaborate approach to investment decision-making than currently in use by most investors. The available data on hedge funds should be corrected for various types of errors, survivorship bias, and autocorrelation. In addition, tools like mean-variance analysis and the Sharpe ratio are no longer appropriate when hedge funds are involved. Including hedge funds in a traditional investment portfolio can significantly improve that portfolio's mean-variance characteristics, but it can also be expected to lead to significantly lower skewness as well as higher kurtosis. This means that the case for hedge funds is a lot less straightforward than often suggested and requires investors to make a definite trade-off between profit and loss potential.