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Hedge funds seem to be a new and exotic phenomenon to many, despite the fact that many of the investment strategies embedded in hedge funds/alternative investments have been around for more than 50 years. Estimates suggest there are more than 6,000 hedge funds managing around $600 billion in assets (L'habitant [2004]). Most of the growth of these funds has taken place in the last 10 years.
Several factors explain this extraordinary development. The first is the unprecedented wealth creation during periods of strong performance in the equity markets, which significantly expanded the base of wealthy private investors. second, institutional investors started showing greater interest in the hedge fund market. Third, there was a need for effective instruments for diversification during periods of falling equity and bond markets. A "stable absolute return" during periods of different market conditions became more and more a target for both private and institutional investors.
Hedge funds are pooled investment vehicles that are privately organized, administered by professional investment managers, and not widely available to the general public. Due to their private nature, hedge funds have less restriction on the use of leverage, short selling, and derivatives than more regulated vehicles such as mutual funds. This allows them to follow investment strategies that are significandy different from the non-leveraged, longonly strategies traditionally followed by "mainstream" investors.
Hedge-fund data on risk and performance are not as available as for mutual funds. Private and institutional investors face a higher "cost" gaining hedge fund data needed to reveal the true risk/reward profile both in absolute terms and relative to a given hedge fund benchmark. Analyzing such relationships should therefore be of great interest to investors who want to gain insights into the statistics of hedge-fund returns.
Academic studies of risk and performance characteristics of hedge-fund investments have been developed by several authors (see, e.g., Agarwal and Naik [2000]; Amin and Kat [2001a, 2001b]; Banz and De Planta [2002]; Brooks and Kat [2001]; Capocci and Hubner [2004]; Favre and Galeano [2001]; Fung and Hsieh [1997, 2001]; and Liang [2001]). Using monthly return data for the period January 1994 to June 2005, we find (in line with the results from many of the studies reported above) that the statistical properties of various hedge-fund indices are...