The Golden Book of Hedge Fund Selection: A Quantitative Approach for Hedge Fund Selection and Hedge Fund Portfolio Risk Management

The traditional hedge fund performance measurements, such as Sharpe ratio and portable alpha, signify only partial indicators of the hedge fund’s risk and performance. Without full transparency of the hedge fund investment characteristics, these risk and rating measures are not particularly useful. Therefore, the problem under study in this research was the effect of fund-specific risk factors on the hedge fund return performance. This study was an investigation of the traditional hedge fund selection measures to address the problem associated with their ineffectiveness and to fill the gap in the research relative to creating an effective hedge fund selection model. In this quantitative study the t test and ANOVA methodologies were applied to existing data from a hedge fund database called Eureka hedge. A population of 7,000 annualized hedge fund returns was used to determine whether the size of a hedge fund, age, strategy, market sector, benchmarks, and past performance were related to future performance. The results from this study concluded that annualized return and age, size and Sharpe ratio, and annualized return and the hedge fund benchmarks did not have statistically significant correlation. However, age and Sharpe ratio, size and annualized return, and annualized return and strategy showed statistically significant correlation. The results from this study can be used for hedge fund selection and may guide investors to improve the quality of their investment model. Implications for positive social change are that improved investment quality will lead to more efficient allocation of capital, which in turn, will lead to higher economic growth in the economy.