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The Hedge Fund: Consistency and Prevailing Return Indices

 

 

The Hedge Fund Index Consistency Index (HFCI),

The Prevailing Return Index (PI)

The Prevailing Reward to Risk Index (PRR)

 

Table of Contents

  1. Overview and Objectives

  2. 18 key Indices Overview: Divided into 3 Main Series of which are divided into 3 Sub-Series

  3. Description of the Specific 18 Indices

    1. The Hedge Fund Consistency Series (HFCI)

    2. The Prevailing Return Series (PI)

    3. The Prevailing Reward to Risk Series (PRR)

No intent is made to:

  1. Provide investment advice, 

  2. Recommend a specific fund or type of funds.

The purpose of this article is to explain:

  1. The purpose of the indices

  2. The reasoning behind the indices

  3. The characteristics of each index

 

Overview and Objectives

The general purpose of the Hedge Fund Index Consistency Index (HFCI), the Prevailing Return Index (PI) and the Prevailing Reward to Risk Index (PRR) is to identify funds that merit further investigation for potential investment.

 

These indices are not meant as a recommendation or prediction of future results. Each index and the indices as a group are offered a research tool as part of the research process and not as a direct recommendation for specific investments.

 

We have created the 18 key Indices / Rankings for the purpose of screening and highlighting funds for the investigation that an investor might not otherwise have found or appreciated. The evolution of these indices is based on the fact that every index has pros and cons in their usefulness.

 

Every index will highlight interesting funds but are also flawed in that they may overlook interesting funds that may merit investigation and or include funds that are not worthy of investigation.  These indices are no exception. 

 

However, each index tries to include a formula that resolves flaws or at least provide a ranking that a related Consistency Indices and Prevailing Indices may fail to achieve. As a group, the 18 indices strive to reveal the maximum number of interesting funds worth investigating. The goal is that as a group, investors will find interesting funds that they may not have found elsewhere and or at provide new insight on a fund the investor heretofore previously looked at.

 

In this regard, each of the 18 indices attempts to do accomplish three things

(1) Highlight interesting funds at large, perhaps not noticed on other ranking indices.

(2) Highlight funds that were not in the other 17 indices.

(The reader will find an overlapping of results from the indices but also funds that do not appear other indices but may be worthy of investigation.)

 (3) Reverse engineer a ranking formula that screen for funds investors are interested in.

For example, regardless of how long a record spans, most investors will disregard a fund if it has not performed well in the most three years. The ranking formulas reward positive performance from the inception of the fund and distinctly for the most recent three years. In this way, the indices identify funds that have done well in the long term and term. Also in the HFCI, it enables the readers to efficiently compare funds of different track lengths.

 

 

 

The 18 key Indices are divided into three groups and subgroups: Back to Table of Contents

 

  1. Hedge Fund Index Consistency Index (HFCI), focused on the reward to risk consistency of the record and the most recent 3 years.

    1. From the Inception of the fund's record (comparing funds of different track lengths)

      1. All Funds

      2. Low Vol Funds

      3. High Funds

    2. Performance for the Last 10 years

      1. All Funds

      2. Low Vol Funds

      3. High Funds

  2. The Prevailing Return Index (PI) focused on the “prevailing” return of the record and the most recent 3 years.

    1. From the Inception of the funds' record; Min record, however, is 10 years

      1. All Funds

      2. Low Vol Funds

      3. High Funds

    2. Performance for the Last 10 years

      1. All Funds

      2. Low Vol Funds

      3. High Funds

  3. The Prevailing Reward to Risk Index (PRR) focused on the “prevailing” reward to risk of the record and the most recent 3 years.

    1. From the Inception of the funds' record; Min record, however, is 10 years

      1. All Funds

      2. Low Vol Funds

      3. High Funds

    2. Performance for the Last 10 years

      1. All Funds

      2. Low Vol Funds

      3. High Funds

 

The Description of the Specific 18 Indices are as follows:  Back to Table of Contents

 

Hedge Fund Consistency Index Series (HFCI)

 

The purpose of the HFCI is to identify which funds have been the most consistent on a reward to risk basis over the course of their track record in the near term, specifically the most recent 3 years. One unique feature, that is designed to compare returns of funds with varying lengths of track records.

 

The notion is that all other factors being equal (such as annualized return), each year a fund has achieved performance in extending their track record, is significant. The simple notion in most elementary terms is that all other performance factors being equal a longer performance is more significant than a shorter record. Certainly, no one would challenge that notion.

 

However, the problem is that attractive shorter-term results will often stand out and unwittingly push out this basic intellectual and objective understanding. Or vice versa. Secondly, there is no easy way to compare the performance of different length records, because rankings are typically compared for like periods. If, for example, one fund prevails in the 3-year rankings, but upon further analysis was dismal in the prior seven years, it would have been effective to screen that out on the initial ranking as the HFCI attempts to do.

The Hedge Fund Consistency Index (HFCI) is applied to the following categories.

  1. The Hedge Fund Consistency Index (HFCI) for All Fund Categories. This index uniquely compares the consistent reward to risk returns of all funds of different length track records by rewarding the ranking score of funds with longer records. For example, in the instance of two funds with the comparable return, drawdowns and standard deviation, the fund with the longer record will be rewarded with a multiplier on its ranking score with the formula: ((# of months -36)/100) +1.

    • This multiplier increases the score (of course eventual ranking) for each year or portion thereof that the fund exceeds 36 months or 3 years. The notion is that once a fund attains a 3-year record it has established a more meaningful record. This formula does 2 things. One it rewards a track for its length, but it also does not exclude a shorter record for comparison. The index also evaluates the reward to risk from inception and the most recent three years, thereby comporting with the desire of the investor looking for both strong long term and nearer term performance.

  2. The Hedge Fund Consistency Index (HFCI) for Funds that Employ Low Vol Strategies The thesis of comparing low vol funds exclusively together is predicated on the notion that the reward to risk characteristics of low vol strategies tend as one would expect exhibit lower volatility but at the same due to their trading style may possibly be exposed to greater possible outlier volatility that is incongruous to all or the majority of their record. 

    • For example, an options trader may sell many way out of the call options on the S&P. Invariably, these options will expire worthless and the option seller’s track record will appear consistent and may appear to be “low vol”.  However, in an outlier market condition in which the market spikes inversely precipitously up, the fund manager may experience extreme volatility or losses that would otherwise be extremely out of character of its heretofore low vol history. 

    • However, the notion here is that “low vol” funds may not necessarily provide lower risk than “high vol” funds but a different type of risk. 2008, for example, was a rude awakening for many investors who were in “low vol” funds that were believed to be lower risk. The other question that this stirs up, in which category, the “low vol” fund or high vol fund category is most likely to replicate successful returns going forward. The point here is not to throw shade on “low vol” funds but rather that an investor considers the implications of each investment type in constructing a diversified portfolio.

    • It is worth noting that the funds were for this group were selected based on style alone without examining their records and yet invariably the best funds in this group did intend exhibit as would be expected significantly lower vol for all or the majority of their record when compared to the high vol group (which will be ostensible for subscribers of this site)

  3. The Hedge Fund Consistency Index (HFCI) for Funds that Employ High Vol Strategies.  The thesis of comparing these funds together is predicated on the notion that while these funds generally exhibit greater volatility than funds trading “low vol” strategies, larger drawdowns are generally not such as incongruous departure as in the funds that employ “low vol” strategies. Certainly, funds in this group can and do experience outlier volatility but the point here is that this vol exhibited in this group is more likely to indicate the risk for those who are at least initially relying on the track record of the fund.

  4. The Hedge Fund Consistency Index (HFCI-10 Yr) for All Fund Categories for the last ten years for funds with at least 10-year records.

  5. The Hedge Fund Consistency Index (HFCI-10 Yr) for Funds that Employ Low Vol Strategies for the last ten years for funds with at least 10-year records.

  6. The Hedge Fund Consistency Index (HFCI-10 Yr) for Funds that Employ High Vol Strategies for the last ten years for funds with at least 10-year records.

 

 

The Prevailing Return Index (PI)     Back to Table of Contents

Arguably more important than consistency, and managing volatility is trying to determine if a fund will survive and not just survive but persist in producing some reasonable proximity of its historical returns.

 

The question that each investor tries to answer or should try to answer is whether the fund’s record, personnel, strategy, and resources are enough to project survivorship and positive returns into the future so the investor can enjoy the power of compounding returns.

 

Warren Buffet arguably has not produced consistent returns or managed volatility, but what he has accomplished which in the final analysis must be more important, that is he has prevailed with the results of strong compounding returns over a long period of time.

 

He has arguably demonstrated that he has the record, personnel, strategy, and resources are sufficient enough to project survivorship and positive returns into the future so the investor can enjoy the power of compounding returns.

The Prevailing Return index is applied to the following categories.

 

 

  1. The Prevailing Return (PI) for All Fund Categories. This funds uniquely compares the Prevailing return of funds. The predicate is an emphasis on return regardless of volatility for the past ten years and the most recent three years. Providing the fund has at least ten years of performance, it will evaluate different length track records by rewarding the ranking score of funds with longer records. For example, in the instance of two funds with the comparable return, drawdowns and standard deviation, the fund with the longer record will have a higher score. However, both funds will appear somewhere in the rankings.

  2. The Prevailing Return (PI) for that Employ Low Vol Strategies.  The thesis of comparing these funds together is predicted that the reward to risk characteristics are often low risk and potential outlier volatility due to outlier events or unique trading errors.

  3. The Prevailing Return (PI) for Funds that Employ High Vol Strategies.  The thesis of comparing these funds together is predicated on the idea that the reward to risk characteristics are often greater volatility and while this group can certainly incur potential outlier volatility such drawdowns are generally not as an unexpected or dramatically different compared to the funds that employ low vol strategies.

  4. The Prevailing Return (PI-10Yr) for All Fund Categories for only the last ten years and most recent three years for funds with at least 10-year records.

  5. The Prevailing Return (PI-10Yr) for that Employ Low Vol Strategies for only the last ten years and most recent three years for funds with at least 10-year records.

  6. The Prevailing Return (PI-10Yr) for Funds that Employ High Vol Strategies.  for only the last ten years and most recent three years for funds with at least 10-year records.

 

The Prevailing Reward to Risk Index (PRR)         Back to Table of Contents

The Prevailing Reward to Risk index is applied to the following categories. 

  1. The Prevailing Reward to Risk (PRR) for All Fund Categories. This index uniquely compares the Prevailing Reward to Risk of funds. The predicate is an emphasis on Reward to Risk regardless of volatility for the past ten years and the most recent three years. Providing the fund has at least ten years of performance, it will evaluate the different length of the track records by rewarding the ranking score of funds with longer records. For example, in the instance of two funds with the comparable return, drawdowns and standard deviation, the fund with the longer record will have a higher score. However, both funds will appear somewhere in the rankings.

  2. The Prevailing Reward to Risk (PRR) for that Employ Low Vol Strategies.  The thesis of comparing these funds together is predicated on that the reward to risk characteristics are often low risk and potential outlier volatility due to outlier events or unique trading errors.

  3. The Prevailing Reward to Risk (PRR) for Funds that Employ High Vol Strategies.  The thesis of comparing these funds together is predicated on that the reward to risk characteristics are often greater volatility and while this group can certainly incur potential outlier volatility such drawdowns are generally not as an unexpected or dramatically different compared to the funds that employ low vol strategies.

  4. The Prevailing Reward to Risk (PRR-10Yr) for All Fund Categories for only the last ten years and most recent three years for funds with at least 10-year records.

  5. The Prevailing Reward to Risk (PRR-10Yr) for that Employ Low Vol Strategies for only the last ten years and most recent three years for funds with at least 10-year records.

  6. The Prevailing Reward to Risk (PRR-10Yr for Funds that Employ High Vol Strategies.  for only the last ten years and most recent three years for funds with at least 10-year records.

No intent is made to:

  1. Provide investment advice, 

  2. Recommend a specific fund or type of funds.

The purpose of this article is to explain:

  1. The purpose of the indices

  2. The reasoning behind the indices

  3. The characteristics of each index

 

Back to Table of Contents