Performance and Evidence · Hedge Funds

A performance percentage is useful only when its calculation is understood. Gross, net, compounded and cash flow dependent returns answer different questions.

Identify what is included

Gross performance may exclude some or all fees and expenses. Net performance should specify the deductions and investor class. Taxes, currency conversion and individual subscription dates can further separate a published result from an investor’s own experience.

Request the return series, calculation method, valuation dates and treatment of distributions. Compare equivalent periods and currencies. A favorable calendar year and an unfavorable rolling year can both be correct, so select the evaluation window before looking at which result is most attractive.

Compound instead of adding

An account beginning at $100 earns 10% and then loses 10%. It becomes $110 and then $99. Its cumulative return is negative 1%, not zero. Multiplying successive growth factors captures the changing capital base.

For three periods with returns of 5%, negative 2% and 4%, the growth factor is 1.05 times 0.98 times 1.04, or 1.07016. The cumulative result is 7.016% before any deductions not already reflected in the reported returns. The simple sum of 7% is close here but is not the exact method.

Separate manager and investor experiences

Time weighted returns seek to isolate portfolio performance from external cash flow timing. Money weighted returns reflect when and how much an investor contributes or withdraws. A large subscription before a loss can make that investor’s experience worse than the fund’s time weighted record.

Do not splice a simulated history, a predecessor portfolio and a live fund record into one unqualified line. Label the segments and examine changes in people, capital, constraints and costs. A net return series with clear dates is a better starting point than a single annualized headline.

Try it yourself

A $100 investment gains 20% in year one and loses 15% in year two, with no cash flows. What is its cumulative return?

Show the worked answer

It ends at $102 because 1.20 times 0.85 equals 1.02. The cumulative gain is 2%, not the 5% obtained by adding the two annual returns.

Further reading

Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. Fund terms, investor eligibility and tax treatment vary by product, account and jurisdiction.

Continue learning