Chapter 9
Measuring Performance and Performance Persistence
It is now time to explore how we measure the performance of a hedge fund manager. This seemingly simple task is actually quite complex. What is performance? Is it the monthly return, the annualized return, the risk-adjusted return, the relative return, or all of the above? Is it gross or net of fees and expenses? Understanding the various methods that can be used to measure performance and learning when one may be preferred to another are covered in this chapter. In the end, there is no single magical number that can be used to measure performance and risk or the compensation one provides for the other. The best approach is a combination of measures that captures the most relevant performance and risk information about a manager, a fund, and the peer group so you can assess the value added that is presented by any opportunity.
Consistency in the measurement is almost as important as the performance or risk number or the measure itself. Why did performance change when the market environment did not, or why didn't the performance change when the markets did? One of the lessons learned from the Madoff scandal was that investors needed to question why his returns remained consistent over time when the proposed strategy being employed should have produced variable results. Investors were too quick to attribute the outperformance to skill without examining where the skill or edge producing the returns was coming from. Had they ...
