Characteristics of Hedge Fund Performance - Sources of Risk-Return Properties -

March 2006
Tomohiro Miura
Yoshinori Tetsuda
Tokiko Shimizu

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With the lowering volatilities in the foreign exchange and stock markets in recent years and historically low interest rates, investments in hedge funds and investment trusts (Japanese mutual funds) by Japanese investors have been increasing. For both hedge funds and investment trusts, investors subcontract asset management to investment managers by paying a management fee. It is pointed out that hedge funds, compared to publicly offered investment trusts, generally have less information disclosure and may have risk characteristics which are difficult to comprehend. On the other hand, investors can, by investing in hedge funds, seek returns that are not subject to fluctuations in market benchmarks. Such characteristics of hedge fund investments are realized through a highly free environment for investment managers. But from the perspective that investors bear risks, not embedded in investment trusts, such as liquidity constraints, liquidation risks, etc., there is a trade-off between risk and return. The reasons behind hedge funds securing positive returns since year 2000 regardless of fluctuations in benchmarks may have been derived from an investment policy aiming for "absolute returns" and less investment constraints.

Notice

This series explains recent economic and financial topics in a plain and concise manner for a wide range of readers. The views expressed in the report are those of the authors and do not necessarily reflect the views of the Bank of Japan.

Comments and questions as well as requests for hard copies should be addressed to Tokiko Shimizu, Director, Financial Markets Department (tokiko.shimizu@boj.or.jp).