Hedge Funds and Managed Futures
What to know
Hedge fund analysis covers strategy classification (equity long/short, event driven, relative value, macro, managed futures/CTA), fee mechanics (2/20 with a high-water mark and sometimes a hurdle), and liquidity terms (lockups, notice periods, gates, side pockets). Database biases - survivorship, backfill, and self-selection - make reported index returns upward biased, so treat index data skeptically. Decompose returns into factor exposures and alpha, and evaluate capacity, concentration, and operational risk (fund administration, valuation policy, auditor quality, custody). Managed futures trend followers can deliver "crisis alpha" in prolonged equity drawdowns but suffer whipsaw in choppy markets. Downside measures (Sortino, Calmar, maximum drawdown, omega) matter more than Sharpe for skewed strategies.
Traps
- Assuming hedge fund indices represent the investable universe.
- Applying incentive fees to total return rather than profit above the high-water mark.
- Using 20% as the recovery gain after a 20% loss - it is 25%.
- Treating a stated strategy label as a factor exposure; returns may just be beta.
Worked example - high-water mark
Invest 100. Year 1 gross return 20% → 120; incentive fee = 20% × 20 = 4, so NAV = 116 and HWM = 116. Year 2 loses 16, NAV = 100. Year 3 gains 12% → 112, still below the 116 HWM, so no incentive fee is charged. Fees resume only above 116. Recovering a loss requires L/(1 − L): a 20% loss needs 25%.