Performance of Hedge Fund Relatively in UK

Performance of fake neckcloth Relatively in UK1.1- swing outg leadgeableness beleaguer in caudexs atomic consequence 18 travelively managed portfolios that downstairspin speckles in publically traded securities. Gaurav S. Amin and Harry M. quat (2000) give tongue to on their disc all over that A forthwit depot is typically defined as a pooled enthronement vehicle that is in private organized, administ enumerated by professional enthronisation managers, and non wide addressable to the public. It charges two(prenominal) a exploit fee and a centering fee. It allows a conciliatory coronation for a miserable proceeds of full- senescen investors (usually the stripped enthronization bills is $1 million) can practice utmost jeopardize techniques. 1 straight geezerhood it is very clear that in the count of alternative investment plebeian hackneyed certificate is non performing rise up. As a extravagantly imperious echos and typically concor d features such(prenominal) as hurdle pass judgment and incentive fees with last wa bourneark provision put off line of descent gives a make separate align to the worrys of managers and investors. 2More anywhere reciprocal coin typically using up a abundant- besides barter for-and-hold fictitious character dodging on regular summation classes, which help to crownture bump premia familiar spirit with candor take a chance, sake rate jeopardy, default on jeopardy etc. However, they ar not very helpful in capturing chance premia associate with alive(p) trade strategies. That is why fudge memory board add togethers into the word picture.In the stratum of 2009, this takes the massive(p)est noteing of the cosmea in the get alonging century. In the category of 2008 the human power saw the greatest fall down of the man thrift. separate of people missing their commerces, lots of comp whatsoever were stopped. The world rescue confront the hig hest losses in the history. These all accompanimentors atomic itemize 18 demonstrate only oneness way to makeover from that greatest downfall that is hedging. 3The last couple of decades fuddle witnessed a rapidly kick upstairsing in the defer coin. Relative to conventional investment portfolios falsify mo crystallizeary re blood line exhibit near unique characteristics they argon ductile with respect to the types of securities they hold and the type of the go down they take.1 Agarwal, V. and Naik, N. (2000). Multi- consummation surgical procedure effort outline of fudge memory board s. The journal of financial and valued analysis. Vol. 35, No,3. PP-327.2 Agarwal, V. and Naik, N. (2004). Risks and portfolio decisions involving put over superior. The study of financial studies, Vol. 17, No.1. PP-64.3 Journal of banking and finance 32(2008) 741-753- duck shop Pricing and Model Uncertainty by Spyridan D. Vrontos, Ioannis D. Vrontos, Daniel Giomouridies.Since the aboriginal 1990s, put off notes go for become an progressively popular addition class. The totality invested globally in parry gold rose from just about $50 one million million million in 1990 to approximately $1 trillion by the last of 2004. And beca physical exertion these bullion characteristically phthisis stantial supplement, they play a furthest to a greater extent than than(prenominal)(prenominal) authoritative role in the global securities grocerys than the size of it of their boodle as positions indicates. Moreover, investments in table coin construct become an important get of the as delimitate mix of institutions and ever wealthy singular investors (Malkiel, B. and Saha, A. (2005).4The number of FOHFs matu dimensionn by 40% among 2001 and 2003, and now comprised al intimately both thirdly of the $650 billion invested in the USAs duck blood commercialize. Due to its nature it is tall(prenominal) to bet the current size of cook inventory exertion. 5Van border storage Advisors estimates that by the goal of 1998 thither were 5380 besiege strain managing $311 in capital, with amidst $800 billion and $1 trillion in total summations, which indicates the higher number of late new entries. So far, hem in blood is establish on American phenomena. Ab expose 90% wangle blood line managers be establish in the US, 9% in Europe and 1% in Asia and elsewhere. Now a days round 5883 cook cash in hand be traffic rough the world. (*Barclay environ data buns).Chart 1 pluss of hedging fund industry from 1997 to 2009. tooth root http//www.barclay dip.com/research/indices/ghs/mum/ misre stick in_Fund.html match to the Barclay misrepresent database the addition of escape fund industry is $1205.6 billion clam.4 Financial cadences, 29th October, 2003.www.van block.comhttp//www.barclay falsify.com/products/ misrepresent-fund-directory.html1.2- question questionsspecifically in this authorship, I want to address both principal(prenominal) questions. starting line one is what is the surgery of bilk fund and FTSE100 over the accomplishment of 2001 to 2008? To esteem the achievement I use terzetto tralatitious run a danger set functioning measuring posture. To give a transgress supposition and matter of easily represent I use the Sharp ratio, the Treynor ratio, and the detonating device plus Pricing Model (CAPM). However, the justice food securities industry proponent is not ineluctably the practiced benchmark for misrepresent specie, therefore, commercialize betas and abnormal repays whitethorn not be the appropriate measures for jeopardizes and ne devilrks. To mitigate this problem, I calculate sapiently ratios, which ar defined as the ratio of the average excess fund affords over the standard deviation.Second question is does bilk notes gives mend return from UK truth merchandiseplace (FTSE100)? To make this comparison I use reverting analy sis where the correlation will exhibit how the table cash in hand act against the FTSE 100.1.3- Objective of the studyThe main objective of this study is to recollect off the public presentation of dip fund intercoursely with the UK equity grocery FTSE 100. In addition, I address in this piece four study escape currency implementation correlation with FTSE100. As a firmness an several(prenominal) investor can easily hear which portfolio will give better return at their investment perspective. This study focuses on UK investors perspective only.In the ult several yrs, lots of studies had been done on this argona homogeneous approximate err and Staum (1998), Brown et al. (1999), Agarwal and Naik (2000), Herzberg and Mozes (2003), Capocci and Hubner (2004), and Malkiel and Saha (2005) analysis the surround fund functioning. n earlyish of the statistical methodological analysis is on the regression with equity markets and rest of all atomic number 18 in the cr oss product ratio. Above all they tried to come up oneself out the return of divergent types of cook fund depending on the market chance and market return.So finally, the purpose of this radical is clearly established, that is to understand flurry fund surgical operation over the UK equity market (FTSE100).1.5- Over believe of the methodologyIn this section I would similar to describe an overview of my methodology. To find out the parry fund surgical process and the FTSE100 markets exercise I use iii handed-down chance-adjusted performance measurement mildews. First one is the Sharpe ratio, secondly, the Treynor ratio and finally, the chapiter Asset Pricing Model (CAPM). I address the Sharpe ratio and the Treynor ratio because these two gives better easy view for an investor to evaluate the hem in fund performance by themselves. However, the Sharpe ratio and the Treyneo ratio measure the excess return of per unit of jeopardy for an investment asset. These two a r used to understand how sanitary the return of an asset compensates the investor for the seek interpreted. When comparing two assets each(prenominal) with the expect return of fund against the same benchmark with risk let go of return, the asset with the higher Sharpe ratio gives more return for the same risk. As a consequent investor can easily understand where to invest.In this paper I use total 287 coin including different types of falsify gold worry- resultant driven (31), environ fund (54), ball-shaped macro instruction (37) and commercialize torpid (165). As a benchmark I use FTSE100 and for the risk muster out rate I use UK 10 year exchequer tie. tout ensemble data were collected from the DataStream which is run by Thomson Reuters the worlds leading credit of talented information for businesses and professionals (http//thomsonreuters.com/).1.6- Definition of the key termsHedge fundIn the early study by Francis C.C. Koh, Winston T.H. Koh , David K.C. Lee , Kok Fai Phoon (2004) stated in their herald that Hedge bullion ar innovative investment structures that were first formd more than 50 years ago by Alfred Winslow Jones. He established a fund with the pursuance features(a) He set up escapes by expend in securities that he determined as undervalued and funding these positions partly by taking fiddling positions in overvalued securities, creating a market torpid position(b) He excessively designed an incentive fee compensation show in which he was paid a percentage of the profits corroborated from his clients assets and(c) He invested his own investment capital in the fund, ensuring that his incentives and those of his investors were aligned and forming an investment partnership. around modern hedge pecuniary resource possess the above listed features, and are set up as confine partnerships with a lucrative incentive-fee structure. In most hedge cash, managers also often have a remarkable raft of their own capital invested in the partnerships. The term hedge fund has been generalise to describe investment strategies that range from the original market-neutral style of Jones to some otherwise strategies and opportunistic situations, including global/macro drop.On the other cross by Liang, B. (1999) stated on his wrap up that there are two study(ip) types of hedge currency, one is inshore and another is offshore. Onshore property are limited partnerships of no more than five hundred investors. Offshore notes are limited liability corporations or partnerships established in the tax revenue neutral jurisdictions that allow investors an probability to invest outside their own rude and calumniate their tax liabilities.Due to the bountiful variety of hedge fund investing strategies, there is no standard method to classify hedge notes smartly. There are at least 8 major databases set up by data vendors and fund advisors. I follow the miscellany used by Eichengreen and Mathieson (19 98), which relied on the mollycoddle/Hedge database. under this classification, there are 8 categories of hedge cash with 7 separate styles and a fund-of- bills category. For my paper I chose three different categories, which are as follows(a) instance driven property. These are finances that take positions on integrated events, such as taking an traded position when companies are undergoing re-structuring or mergers. For example, hedge funds would procure bank debt or high yield incarnate stay puts of companies undergoing re-organization (often ap arcdegreered to as upset securities). Another event-driven strategy is merger arbitrage. These funds keep apart the opportunity to invest just afterward a takeover has been announced. They purchase the shares of the goat companies and bunco the shares of the acquiring companies.(c) Global/Macro funds refer to funds that rely on macroeconomic analysis to take bets on major risk factors, such as currencies, interest rates , telephone circuit indices and commodities. opportunist traffic manager that makes profits from sorts in global economies typically ground in major interest rate shifts. To make profits managers uses leverage and derivatives.(d) commercialize neutral funds refer to funds that bet on copulation price movements utilizing strategies such as long-short equity, stock forefinger arbitrage, convertible bond arbitrage and fixed income arbitrage. Long-short equity funds use the strategy of Jones by taking long positions in selective stocks and going short on other stocks to limit their video to the stock market. Stock index arbitrage funds trade on the spread between index nexts contracts and the cardinal basket of equities. Convertible bond arbitrage funds typically capitalize on the embedded extract in these bonds by get them and shorting the equities. primed(p) income arbitrage bet on the convergence of prices of bonds from the same skipr only with different maturities ov er time. This is the second largest grouping of hedge funds after the Global category.Source Eichengreen and Mathieson (1998).2.1.2- Current scenario of hedge fundsChapter two belles-lettres review2.1- History of hedge fundDespite the increasing interest and new-fashioned knowledge, some studies have been carried out on hedge funds comparing to other investment tools resembling vulgar funds. An analysis of Hedge Fund performance 1984-2000 by Capocci Daniel using one of the greatest hedge fund database ever used on his working paper (2796 individual funds including 801 dissolved), to investigate hedge funds performance using sundry(a) asset- set models, including an extension phone from of Carharts (1997) model combined with Fama and French (1998), Agarwal and Naik (2000) models that take into account the fact that some hedge funds invest in emerging market bond. At the end they found that their model does a better job describing hedge funds behaviour. That appears particularl y good for the Event Driven, Global Macro, US Opportunistic, faithfulness non-Hedge and Sector funds.Since the early 1990s, when around 2000 hedge funds were managing assets totalling capital of $60 billion, the subsequent growth in the number and asset base of hedge funds has never really been refuted. The industry only dumbfounded from a relative slowdown in 1998, solely since indeed has enjoyed a renew animation with an estimated total of 10,000funds managing more than a trillion US dollars by the end of 2006. The increment impetus of the sector remained remarkably sustained during the stock market collapse that started in March 2000, when the NASDAQ composite Index reached an incomparable high of 5,132 and finished three years later with a offend level of 1,253. In the meantime, the global met asset value (NAV) of hedge funds proceed to grow at a steady rate of 10.6% (Van Hedge pecuniary resource Advisors International, 2002), contrasting with a decrease of 2.7% in th e worldwide plebeian fund industry ( Investment Company Institute, 2003). In 2001, Capocci and Hubner(2004) estimated that there were 6,000 hedge fund managing around $400 billion. In 2007, Capocci, Duquenne and Hubner (2007) estimated that there were 10,000 hedge funds managing around $1 trillion. This is a growth of 11% in the number of funds and 26% in assets over six years (6PhD thesis paper by Daniel P.J. Capocci).Other studies from practitioners Hennessee (1994), and Oberuc (1994) also showed an evidence of superior performance in the typeface of hedge funds. Ackernann and Al. (1999) and Liang (1999) who compared the performance of hedge funds to vernacular funds and several indices, found that hedge funds never-endingly arrive ated better performance than mutual funds. Their performance was not better than the performance of the market indices shooted. They also indicated that the returns in hedge funds were more unstable than both the returns of mutual funds and thos e of market indices. According to Brown and Al. (1997) hedge funds showing good performance in the first part of the year centre the volatility of their portfolio in the second half of the year (Capocci Daniel- An analysis of hedge fund performance 1984-2000). Taking all these results into account hedge funds seems a good investment tool.6 PhD thesis paper by Daniel P.J. Capocci. Electronic copy available at http//ssrn.com/abstract=1008319.2.1.1- Facts and purpose of development in hedge fundsAs a result of flexible investment strategies, a better manager inventive alignment, sophisticated investors, and limited SEC regulations hedge funds have gained incredible popularity. In the report of Agarwal, V. and Naik, N. (2004) stated that it is sanitary accepted that the world of financial securities is a multifactor world exist of different risk factors, each associated with its own factor risk premium, and that no single investment strategy can orthodontic braces the perfect ri sk factor space. Therefore investors wishing to earn risk premia associated with different risk factors need to employ different kinds of investment strategies. Sophisticated investors, standardized endowments and subvention funds, seem to have recognized this fact as their portfolios consist of mutual funds as well as hedge funds.1 interchangeable funds typically employ a long-only vitiate-and-hold-type strategy on standard asset classes, and help enthral risk premia associated with equity risk, interest rate risk, default risk, etc. However, they are not very helpful in capturing risk premia associated with dynamic trading strategies or spread-based strategies. This is where hedge funds come into the picture. opposed mutual funds, hedge funds are not evaluated against a peaceable benchmark and therefore can follow more dynamic trading strategies. Moreover, they can take long as well as short positions in securities, and therefore can bet on capitalization spreads or value- growth spreads. As a result, hedge funds can spin exposure to risk factors that traditionalistic long-only strategies cannot.However, investor can create exposure wish hedge funds by trading on their own account, in utilize they encounter many frictions due to incompleteness of markets like the publicly traded derivatives market and the finance market. Moreover, the derivatives market for standardized contracts has grown a great sens in recent years, still it is very costly for an investor to create a customized payoff on individual securities. The same is true for the financing market as well, where investors encounter difficulties shorting securities and obtaining leverage. These frictions make it difficult for investors to create hedge fund-like payoffs by trading on their own accounts.According to Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004) in 1990, the stainless hedge fund industry was estimated at just about US$20 billion. At of 2004, there are close to 7000 hedge f unds worldwide, managing more than US$830 billion. Additionally, about US$200-ccc billion is estimated to be in privately managed accounts. musical composition high net price individuals remain the main source of capital, hedge funds are becoming more popular among institutional and share investors. Funds of hedge funds and other hedge fund-linked products are increasingly being marketed to the retail market. While hedge funds are well established in the United States and Europe, they have only begun to grow sharply in Asia. According to Asia Hedge magazine, there are more than 300 hedge funds operating in Asia (including those in lacquer and Australia), of which 30 were established in year 2000 and 20 in 2001. In 2003, 90 new hedge funds were started in Asia, compared with 66 in 2002, correspond to an estimate by the Bank of Bermuda. In 2004 more than US$15 billion, hedge fund investments in Asia are expected to grow rapidly. some(prenominal) factors support this view. Asian hedge funds currently account for a tiny slice of the global hedge fund pie and a unspotted trickle of the total financial wealth of high net worth individuals in Asia.Hedge funds have posted agreeable returns. From 1987 to 2001, the Hennessee Hedge Fund Index posted annualised returns of 18%, higher than the SPs 13.5%. Hedge funds are seen as a natural hedge for compulsive downside risk because they employ exotic investment strategies believed to generate returns that are unrelated to traditional asset classes. Hedge funds vary in their strategies. questionable macro funds, such as Quantum Fund, generally take a directing view by betting on a particular bond market, say, or a currency movement. Other funds specialize in bodily events, such as mergers or bankruptcies, or simply feel for pricing anomalies the stock markets. Hedge funds vary widely in both their investment strategies and the amount of financial leverage. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)There ar e a number of factors behind the meteoric rise in demand for hedge funds. The unprecedented bull-run in the US equity markets during the 1990s expanded investment portfolios. This led an increased awareness on the need for diversification. The bursting of the technology and internet bubbles, the fibril of corporate scandals that hit corporate America and the uncertainties in the US economy have led to a general decline in stock markets worldwide. This in turn provided fresh impetus for hedge funds as investors searched for absolute returns. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)Unlike registered investment companies, hedge funds are not required to publicly disclose performance and holdings information that superpower be construed as solicitation materials. Since the early 1990s, there has been a growing interest in the use of hedge funds amongst both institutional and high net worth individuals. Due to their private nature, it is difficult to obtain nice information a bout the operations of individual hedge funds and time-tested summary statistics about the industry as a whole. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)Hedge funds are known to be growing in size and diversity. As at the end of 1997, the MAR/Hedge database immortalizeed more than 700 hedge fund managing assets of US$90 billion. This is only a overtone picture of the industry, as many funds are not listed with MAR/Hedge. In practical terms, it is not easy to estimate the current size of the hedge fund industry un slight all funds are correct or obligated to register their operations with a common authority. stomach and computerized tomography (2001) estimated that, as at April 2001, there are around 6000 hedge funds with an estimated US $400 billion in capital under circumspection and US $1 trillion in total assets. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)According to Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004) three interesting features differentiate hedge fu nds from other forms of managed funds. Most hedge funds are midget and organized around a few experienced investment professionals. In fact, more than half of U.S Hedge Funds manage amounts of less than US$25 million. Further, most hedge funds are leveraged. It is estimated that 70 per cent of hedge funds use leverage and about 18% borrowed more than one dollar for every dollar of capital. (See Eichengreen and Mathieson (1998). Another peculiar feature is the short bread and barelyter span of hedge funds. Hedge funds have an average life span of about 3.5 years (See Stefano Lavinio (2000) pp 128). Very few have a cross record of more than 10 years. These features lead many to view hedge funds, as risky and opportunistic.In the early study by Fung and Hsieh (2001), they use plectron like payoffs to view the risks of cut following hedge funds. They saw that the trend following are typically commodity trading advisors (CTAs) who test to profit from trends in commodity prices usi ng technical indicators. According to Fung and Hsieh (2001) trend followers are particularly interesting in that not only are their returns uncorrelated with the standard equity, bond, currency, and commodity indices, simply their returns die hard to exhibit excerpt like features. They race to be large and positive during the stovepipe and scald performing calendar months of world equity indices. They cite evidence by Fung and Hsieh (1997) who show that if one divided up the states of the world into five states based on the return on the MSCI equity world index, trend followers ladder to outperform when the MSCI equity return is at its lowest and highest. The human relationship between trend followers and the equity market is non-linear and U-shaped. Although returns of trend following funds have a low beta against equities on average, the state-dependent betas tend to be positive in up-markets and negative in down markets.As a result, Fung and Hsieh (2001) assume that the simplest trend following strategy has the same payout as a structured option known as the spirit concealment straddle. The proprietor of a look sustain call option has the right to buy the underlying asset at the lowest price over the life of the option. Similarly, a look back put option allows the owner to sell at the highest price. The combination of these two options is the look back straddle, which delivers the ex-post maximum payout of any trend following strategy. Fung and Hsieh (2001) then demonstrate empirically that look back straddle returns resemble the returns of trend following hedge funds. building on this pioneer work, Fung and Hsieh (2004) propose seven factors that explain aggregate hedge fund returns. These seven factors include the excess return on the SP 500 index, the Wilshire subatomic cap minus large cap index return, the term spread, the book of facts spread, and trend following factors for bonds, currencies, and commodities. They show that their sev en factor model well explains variation in aggregate hedge fund returns. In addition, they find that equity long/short hedge funds tend to misdirect positively on the SP 500 index factor and the small cap minus large cap factor. These results are consistent with the ceremony that equity long/short hedge funds typically have a small positive exposure to stocks and tend to be long small stocks and short large stocks. Fung and Hsieh (2004) also find that fixed income funds on the other hand tend to load negatively on the change in the credit spread, where the credit spread is measured as the distinction between the yield on Moodys Baa bonds and the yield on the 10-year constant maturity exchequer bond. The reason is that fixed income funds typically buy bonds with lower credit ratings and/or less liquidity and then hedge the interest rate risk by shorting US Treasury bonds, which have the highest credit rating and are more liquid.However, Agarwal and Naik (2004) also propose a multi -factor model to explain hedge fund risks. They find that non-linear option like payoffs are not restricted to trend followers and risk arbitrageurs, but are an integral feature of payoffs for a wide range of hedge fund strategies. In particular they observe that the payoffs on a large number of hedge fund strategies look like those from pen a put option on the equity index. These strategies include risk arbitrage, distressed debt, convertible arbitrage, and relative value arbitrage. Consistent with the exposure of these strategies to the risks borne by sellers of equity index put options, Agarwal and Naik (2004) find that these hedge funds suffer from earthshaking left tail risk which tends to coincide with severe market downturns.The performance of hedge fund in 2008 was very shocking like more than ten years ago. Teo, M (2009) stated that in the month of frightful 1998 alone LTCM lost 45% of its capital in the raise of the wide liquidity event triggered by the Russian rubble default. carve up of pedantic literature has shown that the year 2007 and 2008 was the worst performance of hedge fund. As we know that hedge fund managers make portfolio by taking position in equity market and another fund, but unfortunately the world equity market goes downside. As a result investors who wish to stand future financial maelstroms should take note of the non-linear relationship between hedge fund returns and the equity market.2.3- Limitations (previous)With respect to lightly regulated investment vehicles with great treading flexibility, hedge funds often pursue highly sophisticated investment strategies. Hedge funds promise absolute returns to their investor leading to a belief that they hold factor-neutral portfolios. With this in mind, hedge funds have some limitations. In the early studies many researchers discussed and explain that obstacles.First of all if we consider the measurement model of hedge funds performance, most of the researcher use traditional performance measure model like, Sharpe ratio, Treynor ratio and Jensen alpha which are not passable for the performance evaluation of hedge funds. Fung and Hsieh (2000) and Roy (2003) stated that is incorrect to use these performance measures t evaluate the hedge funds strategies. Brooks and kat (2002), Kat (2003), Mahdavi (2004) and Murguia and Umemoto (2004) also mentioned that the Sharpe ratio does not represent the true performance of hedge funds because it does not take into consideration the asymmetry returns of these funds. As a result Perello (2007) propose to use the downside risk framework like Sortino ratio, the height potential ratio and Omega measure as alternative performance measure. Moreover, Chung, Rosenberg and Tomeo (2004) and Scherer (2004) showed that Sortino ratio makes it possible to the investors to evaluate the risk and the performance of the hedge funds more sustainably than Sharpe ratio.Secondly, according to Ackermann et al. (1999) and to Fung and Hsie h (2000), two upward warpes exist in the persona of hedge funds. They do not exist in the case of mutual funds, and they both have an opposite impact to the survivorship bias. Survivorship bias is an important issue in hedge funds performance studies (see Carhart and al. 2000). This bias is present when a database contains only funds that have data for the whole period studies. In this case, there is a risk of overestimating the mean performance because the funds that would have ceased to exist because of their bad performance would not be taken into account. The two upward biases exist because, since hedge funds are not allowed to advertise, they consider cellular inclusion in a database primarily as a market tool. The first phenomenon stressed by Ackermann and al. (1999) and called the self-selection bias is present because funds that realize good performance have less incentive to report their performance to data providers in order to attract new investors. Malkiel, B. and Sa ha, A. (2005) stated in their report that Databases available at any point in time tend to reflect the returns earned by currently existing hedge funds but they do not include the returns from hedge funds that existed at some time in the past but are presently not in existence (i.e., the truly d.o.a. funds) or exist but no longer report their results (the defunct funds). unsuccessful hedge funds have difficulties obtaining new assets. Hence, they tend to close, leaving only the more successful funds in the database. But some funds stop reporting not because they are unsuccessful but because they do not want to attract new investment.The second point called consequence history bias or backfilled bias (Fung and Hsieh 2000) occurs because after inclusion a funds performance history is backfilled. This may cause an upward bias because funds with less satisfactory performance history are less likely to apply for inclusion than funds with good performance history (Capocci Daniel 2001, An analysis of hedge fund performance 1984- 2000).Performance of Hedge Fund Relatively in UKPerformance of Hedge Fund Relatively in UK1.1- IntroductionHedge funds are actively managed portfolios that hold positions in publicly traded securities. Gaurav S. Amin and Harry M. Kat (2000) stated on their report that A hedge fund is typically defined as a pooled investment vehicle that is privately organized, administrated by professional investment managers, and not widely available to the public. It charges both a performance fee and a management fee. It allows a flexible investment for a small number of large investors (usually the minimum investment is $1 million) can use high risk techniques. 1Now days it is very clear that in the matter of alternative investment mutual fund is not performing well. As a high absolute returns and typically have features such as hurdle rates and incentive fees with high watermark provision hedge fund gives a better align to the interests of managers a nd investors. 2Moreover mutual funds typically use a long-only buy-and-hold type strategy on standard asset classes, which help to capture risk premia associate with equity risk, interest rate risk, default risk etc. However, they are not very helpful in capturing risk premia associate with dynamic trading strategies. That is why hedge fund comes into the picture.In the year of 2009, this takes the greatest history of the world in the following century. In the year of 2008 the world saw the greatest fall down of the world economy. Lots of people missing their jobs, lots of company were stopped. The world economy faced the highest losses in the history. These all factors are showing only one way to makeover from that greatest downfall that is hedging. 3The last couple of decades have witnessed a rapidly growing in the hedge funds. Relative to traditional investment portfolios hedge funds exhibit some unique characteristics they are flexible with respect to the types of securities the y hold and the type of the position they take.1 Agarwal, V. and Naik, N. (2000). Multi-period performance persistence analysis of hedge fund s. The journal of financial and quantitative analysis. Vol. 35, No,3. PP-327.2 Agarwal, V. and Naik, N. (2004). Risks and portfolio decisions involving hedge funds. The review of financial studies, Vol. 17, No.1. PP-64.3 Journal of banking and finance 32(2008) 741-753- Hedge Fund Pricing and Model Uncertainty by Spyridan D. Vrontos, Ioannis D. Vrontos, Daniel Giomouridies.Since the early 1990s, hedge funds have become an increasingly popular asset class. The amount invested globally in hedge funds rose from approximately $50 billion in 1990 to approximately $1 trillion by the end of 2004. And because these funds characteristically use stantial leverage, they play a far more important role in the global securities markets than the size of their net assets indicates. Moreover, investments in hedge funds have become an important part of the asset mix of institutions and ever wealthy individual investors (Malkiel, B. and Saha, A. (2005).4The number of FOHFs increase by 40% between 2001 and 2003, and now comprised almost two third of the $650 billion invested in the USAs hedge fund market. Due to its nature it is difficult to estimate the current size of hedge fund industry. 5Van Hedge Fund Advisors estimates that by the end of 1998 there were 5380 hedge fund managing $311 in capital, with between $800 billion and $1 trillion in total assets, which indicates the higher number of recent new entries. So far, hedge fund is based on American phenomena. About 90% hedge fund managers are based in the US, 9% in Europe and 1% in Asia and elsewhere. Now a days around 5883 hedge funds are trading around the world. (*Barclay Hedge database).Chart 1 Assets of Hedge fund industry from 1997 to 2009.Source http//www.barclayhedge.com/research/indices/ghs/mum/Hedge_Fund.htmlAccording to the Barclay hedge database the asset of hedge fund indust ry is $1205.6 billion dollar.4 Financial times, 29th October, 2003.www.vanhedge.comhttp//www.barclayhedge.com/products/hedge-fund-directory.html1.2- Research questionsSpecifically in this paper, I want to address two main questions. First one is what is the performance of hedge fund and FTSE100 over the period of 2001 to 2008? To evaluate the performance I use three traditional risk adjusted performance measurement model. To give a better idea and matter of easily understand I use the Sharp ratio, the Treynor ratio, and the Capital Asset Pricing Model (CAPM). However, the equity market index is not necessarily the right benchmark for hedge funds, therefore, market betas and abnormal returns may not be the appropriate measures for risks and profits. To mitigate this problem, I calculate sharp ratios, which are defined as the ratio of the average excess fund returns over the standard deviation.Second question is does hedge funds gives better return from UK equity market (FTSE100)? To make this comparison I use regression analysis where the correlation will show how the hedge funds act against the FTSE 100.1.3- Objective of the studyThe main objective of this study is to find out the performance of Hedge fund relatively with the UK equity market FTSE 100. In addition, I address in this paper four major hedge funds performance correlation with FTSE100. As a result an individual investor can easily understand which portfolio will give better return at their investment perspective. This study focuses on UK investors perspective only.In the past several years, lots of studies had been done on this area like Park and Staum (1998), Brown et al. (1999), Agarwal and Naik (2000), Herzberg and Mozes (2003), Capocci and Hubner (2004), and Malkiel and Saha (2005) analysis the hedge fund performance. Most of the statistical methodology is on the regression with equity markets and rest of all are in the cross product ratio. Above all they tried to find out the return of differ ent types of hedge fund depending on the market risk and market return.So finally, the purpose of this paper is clearly established, that is to understand hedge fund performance over the UK equity market (FTSE100).1.5- Overview of the methodologyIn this section I would like to describe an overview of my methodology. To find out the hedge fund performance and the FTSE100 markets performance I use three traditional risk-adjusted performance measurement models. First one is the Sharpe ratio, secondly, the Treynor ratio and finally, the Capital Asset Pricing Model (CAPM). I address the Sharpe ratio and the Treynor ratio because these two gives better easy view for an investor to evaluate the hedge fund performance by themselves. However, the Sharpe ratio and the Treyneo ratio measure the excess return of per unit of risk for an investment asset. These two are used to understand how well the return of an asset compensates the investor for the risk taken. When comparing two assets each wi th the expected return of fund against the same benchmark with risk free return, the asset with the higher Sharpe ratio gives more return for the same risk. As a result investor can easily understand where to invest.In this paper I use total 287 funds including different types of hedge funds like- Event driven (31), Hedge fund (54), Global macro (37) and Market neutral (165). As a benchmark I use FTSE100 and for the risk free rate I use UK 10 year Treasury bond. All data were collected from the DataStream which is run by Thomson Reuters the worlds leading source of intelligent information for businesses and professionals (http//thomsonreuters.com/).1.6- Definition of the key termsHedge fundIn the early study by Francis C.C. Koh, Winston T.H. Koh , David K.C. Lee, Kok Fai Phoon (2004) stated in their report that Hedge Funds are innovative investment structures that were first created more than 50 years ago by Alfred Winslow Jones. He established a fund with the following features(a) He set up hedges by investing in securities that he determined as undervalued and funding these positions partly by taking short positions in overvalued securities, creating a market neutral position(b) He also designed an incentive fee compensation arrangement in which he was paid a percentage of the profits realise from his clients assets and(c) He invested his own investment capital in the fund, ensuring that his incentives and those of his investors were aligned and forming an investment partnership. Most modern hedge funds possess the above listed features, and are set up as limited partnerships with a lucrative incentive-fee structure. In most hedge funds, managers also often have a significant portion of their own capital invested in the partnerships. The term hedge fund has been generalized to describe investment strategies that range from the original market-neutral style of Jones to many other strategies and opportunistic situations, including global/macro investing.On th e other report by Liang, B. (1999) stated on his report that there are two major types of hedge funds, one is inshore and another is offshore. Onshore funds are limited partnerships of no more than 500 investors. Offshore funds are limited liability corporations or partnerships established in the tax neutral jurisdictions that allow investors an opportunity to invest outside their own country and minimize their tax liabilities.Due to the large variety of hedge fund investing strategies, there is no standard method to classify hedge funds smartly. There are at least 8 major databases set up by data vendors and fund advisors. I follow the classification used by Eichengreen and Mathieson (1998), which relied on the MAR/Hedge database. Under this classification, there are 8 categories of hedge funds with 7 differentiated styles and a fund-of-funds category. For my paper I chose three different categories, which are as follows(a) Event driven funds. These are funds that take positions on corporate events, such as taking an arbitraged position when companies are undergoing re-structuring or mergers. For example, hedge funds would purchase bank debt or high yield corporate bonds of companies undergoing re-organization (often referred to as distressed securities). Another event-driven strategy is merger arbitrage. These funds seize the opportunity to invest just after a takeover has been announced. They purchase the shares of the target companies and short the shares of the acquiring companies.(c) Global/Macro funds refer to funds that rely on macroeconomic analysis to take bets on major risk factors, such as currencies, interest rates, stock indices and commodities. Opportunistic trading manager that makes profits from changes in global economies typically based in major interest rate shifts. To make profits managers uses leverage and derivatives.(d) Market neutral funds refer to funds that bet on relative price movements utilizing strategies such as long-short equit y, stock index arbitrage, convertible bond arbitrage and fixed income arbitrage. Long-short equity funds use the strategy of Jones by taking long positions in selective stocks and going short on other stocks to limit their exposure to the stock market. Stock index arbitrage funds trade on the spread between index futures contracts and the underlying basket of equities. Convertible bond arbitrage funds typically capitalize on the embedded option in these bonds by purchasing them and shorting the equities. Fixed income arbitrage bet on the convergence of prices of bonds from the same issuer but with different maturities over time. This is the second largest grouping of hedge funds after the Global category.Source Eichengreen and Mathieson (1998).2.1.2- Current scenario of hedge fundsChapter twoLiterature review2.1- History of hedge fundDespite the increasing interest and recent development, few studies have been carried out on hedge funds comparing to other investment tools like mutua l funds. An analysis of Hedge Fund performance 1984-2000 by Capocci Daniel using one of the greatest hedge fund database ever used on his working paper (2796 individual funds including 801 dissolved), to investigate hedge funds performance using various asset-pricing models, including an extension from of Carharts (1997) model combined with Fama and French (1998), Agarwal and Naik (2000) models that take into account the fact that some hedge funds invest in emerging market bond. At the end they found that their model does a better job describing hedge funds behaviour. That appears particularly good for the Event Driven, Global Macro, US Opportunistic, Equity non-Hedge and Sector funds.Since the early 1990s, when around 2000 hedge funds were managing assets totalling capital of $60 billion, the subsequent growth in the number and asset base of hedge funds has never really been refuted. The industry only suffered from a relative slowdown in 1998, but since then has enjoyed a renewed v itality with an estimated total of 10,000funds managing more than a trillion US dollars by the end of 2006. The growing trend of the sector remained remarkably sustained during the stock market collapse that started in March 2000, when the NASDAQ composite Index reached an all-time high of 5,132 and finished three years later with a floor level of 1,253. In the meantime, the global met asset value (NAV) of hedge funds continued to grow at a steady rate of 10.6% (Van Hedge Funds Advisors International, 2002), contrasting with a decrease of 2.7% in the worldwide mutual fund industry ( Investment Company Institute, 2003). In 2001, Capocci and Hubner(2004) estimated that there were 6,000 hedge fund managing around $400 billion. In 2007, Capocci, Duquenne and Hubner (2007) estimated that there were 10,000 hedge funds managing around $1 trillion. This is a growth of 11% in the number of funds and 26% in assets over six years (6PhD thesis paper by Daniel P.J. Capocci).Other studies from pr actitioners Hennessee (1994), and Oberuc (1994) also showed an evidence of superior performance in the case of hedge funds. Ackernann and Al. (1999) and Liang (1999) who compared the performance of hedge funds to mutual funds and several indices, found that hedge funds constantly obtained better performance than mutual funds. Their performance was not better than the performance of the market indices considered. They also indicated that the returns in hedge funds were more unstable than both the returns of mutual funds and those of market indices. According to Brown and Al. (1997) hedge funds showing good performance in the first part of the year reduce the volatility of their portfolio in the second half of the year (Capocci Daniel- An analysis of hedge fund performance 1984-2000). Taking all these results into account hedge funds seems a good investment tool.6 PhD thesis paper by Daniel P.J. Capocci. Electronic copy available at http//ssrn.com/abstract=1008319.2.1.1- Facts and fin ding of development in hedge fundsAs a result of flexible investment strategies, a better manager inventive alignment, sophisticated investors, and limited SEC regulations hedge funds have gained incredible popularity. In the report of Agarwal, V. and Naik, N. (2004) stated that it is well accepted that the world of financial securities is a multifactor world consisting of different risk factors, each associated with its own factor risk premium, and that no single investment strategy can span the entire risk factor space. Therefore investors wishing to earn risk premia associated with different risk factors need to employ different kinds of investment strategies. Sophisticated investors, like endowments and pension funds, seem to have recognized this fact as their portfolios consist of mutual funds as well as hedge funds.1 Mutual funds typically employ a long-only buy-and-hold-type strategy on standard asset classes, and help capture risk premia associated with equity risk, interest rate risk, default risk, etc. However, they are not very helpful in capturing risk premia associated with dynamic trading strategies or spread-based strategies. This is where hedge funds come into the picture. Unlike mutual funds, hedge funds are not evaluated against a passive benchmark and therefore can follow more dynamic trading strategies. Moreover, they can take long as well as short positions in securities, and therefore can bet on capitalization spreads or value-growth spreads. As a result, hedge funds can offer exposure to risk factors that traditional long-only strategies cannot.However, investor can create exposure like hedge funds by trading on their own account, in practice they encounter many frictions due to incompleteness of markets like the publicly traded derivatives market and the financing market. Moreover, the derivatives market for standardized contracts has grown a great deal in recent years, still it is very costly for an investor to create a customized payo ff on individual securities. The same is true for the financing market as well, where investors encounter difficulties shorting securities and obtaining leverage. These frictions make it difficult for investors to create hedge fund-like payoffs by trading on their own accounts.According to Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004) in 1990, the entire hedge fund industry was estimated at about US$20 billion. At of 2004, there are close to 7000 hedge funds worldwide, managing more than US$830 billion. Additionally, about US$200-300 billion is estimated to be in privately managed accounts. While high net worth individuals remain the main source of capital, hedge funds are becoming more popular among institutional and retail investors. Funds of hedge funds and other hedge fund-linked products are increasingly being marketed to the retail market. While hedge funds are well established in the United States and Europe, they have only begun to grow aggressively in Asia. According to As ia Hedge magazine, there are more than 300 hedge funds operating in Asia (including those in Japan and Australia), of which 30 were established in year 2000 and 20 in 2001. In 2003, 90 new hedge funds were started in Asia, compared with 66 in 2002, according to an estimate by the Bank of Bermuda. In 2004 more than US$15 billion, hedge fund investments in Asia are expected to grow rapidly. Several factors support this view. Asian hedge funds currently account for a tiny slice of the global hedge fund pie and a mere trickle of the total financial wealth of high net worth individuals in Asia.Hedge funds have posted attractive returns. From 1987 to 2001, the Hennessee Hedge Fund Index posted annualised returns of 18%, higher than the SPs 13.5%. Hedge funds are seen as a natural hedge for controlling downside risk because they employ exotic investment strategies believed to generate returns that are uncorrelated to traditional asset classes. Hedge funds vary in their strategies. So-calle d macro funds, such as Quantum Fund, generally take a directional view by betting on a particular bond market, say, or a currency movement. Other funds specialize in corporate events, such as mergers or bankruptcies, or simply look for pricing anomalies the stock markets. Hedge funds vary widely in both their investment strategies and the amount of financial leverage. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)There are a number of factors behind the meteoric rise in demand for hedge funds. The unprecedented bull-run in the US equity markets during the 1990s expanded investment portfolios. This led an increased awareness on the need for diversification. The bursting of the technology and Internet bubbles, the string of corporate scandals that hit corporate America and the uncertainties in the US economy have led to a general decline in stock markets worldwide. This in turn provided fresh impetus for hedge funds as investors searched for absolute returns. (Koh, F., Koh,W,. Lee, D ,. and Phoon, K. (2004)Unlike registered investment companies, hedge funds are not required to publicly disclose performance and holdings information that might be construed as solicitation materials. Since the early 1990s, there has been a growing interest in the use of hedge funds amongst both institutional and high net worth individuals. Due to their private nature, it is difficult to obtain adequate information about the operations of individual hedge funds and reliable summary statistics about the industry as a whole. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)Hedge funds are known to be growing in size and diversity. As at the end of 1997, the MAR/Hedge database recorded more than 700 hedge fund managing assets of US$90 billion. This is only a partial picture of the industry, as many funds are not listed with MAR/Hedge. In practical terms, it is not easy to estimate the current size of the hedge fund industry unless all funds are regulated or obligated to register their op erations with a common authority. Brooks and Kat (2001) estimated that, as at April 2001, there are around 6000 hedge funds with an estimated US $400 billion in capital under management and US $1 trillion in total assets. (Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004)According to Koh, F., Koh,W,. Lee, D,. and Phoon, K. (2004) three interesting features differentiate hedge funds from other forms of managed funds. Most hedge funds are small and organized around a few experienced investment professionals. In fact, more than half of U.S Hedge Funds manage amounts of less than US$25 million. Further, most hedge funds are leveraged. It is estimated that 70 per cent of hedge funds use leverage and about 18% borrowed more than one dollar for every dollar of capital. (See Eichengreen and Mathieson (1998). Another peculiar feature is the short life span of hedge funds. Hedge funds have an average life span of about 3.5 years (See Stefano Lavinio (2000) pp 128). Very few have a track record o f more than 10 years. These features lead many to view hedge funds, as risky and opportunistic.In the early study by Fung and Hsieh (2001), they use option like payoffs to view the risks of trend following hedge funds. They saw that the trend followers are typically commodity trading advisors (CTAs) who attempt to profit from trends in commodity prices using technical indicators. According to Fung and Hsieh (2001) trend followers are particularly interesting in that not only are their returns uncorrelated with the standard equity, bond, currency, and commodity indices, but their returns tend to exhibit option like features. They tend to be large and positive during the best and worst performing months of world equity indices. They cite evidence by Fung and Hsieh (1997) who show that if one divided up the states of the world into five states based on the return on the MSCI equity world index, trend followers tend to outperform when the MSCI equity return is at its lowest and highest. The relationship between trend followers and the equity market is non-linear and U-shaped. Although returns of trend following funds have a low beta against equities on average, the state-dependent betas tend to be positive in up-markets and negative in down markets.As a result, Fung and Hsieh (2001) assume that the simplest trend following strategy has the same payout as a structured option known as the look back straddle. The owner of a look back call option has the right to buy the underlying asset at the lowest price over the life of the option. Similarly, a look back put option allows the owner to sell at the highest price. The combination of these two options is the look back straddle, which delivers the ex-post maximum payout of any trend following strategy. Fung and Hsieh (2001) then demonstrate empirically that look back straddle returns resemble the returns of trend following hedge funds.Building on this pioneer work, Fung and Hsieh (2004) propose seven factors that expla in aggregate hedge fund returns. These seven factors include the excess return on the SP 500 index, the Wilshire small cap minus large cap index return, the term spread, the credit spread, and trend following factors for bonds, currencies, and commodities. They show that their seven factor model well explains variation in aggregate hedge fund returns. In addition, they find that equity long/short hedge funds tend to load positively on the SP 500 index factor and the small cap minus large cap factor. These results are consistent with the observation that equity long/short hedge funds typically have a small positive exposure to stocks and tend to be long small stocks and short large stocks. Fung and Hsieh (2004) also find that fixed income funds on the other hand tend to load negatively on the change in the credit spread, where the credit spread is measured as the difference between the yield on Moodys Baa bonds and the yield on the 10-year constant maturity Treasury bond. The reason is that fixed income funds typically buy bonds with lower credit ratings and/or less liquidity and then hedge the interest rate risk by shorting US Treasury bonds, which have the highest credit rating and are more liquid.However, Agarwal and Naik (2004) also propose a multi-factor model to explain hedge fund risks. They find that non-linear option like payoffs are not restricted to trend followers and risk arbitrageurs, but are an integral feature of payoffs for a wide range of hedge fund strategies. In particular they observe that the payoffs on a large number of hedge fund strategies look like those from writing a put option on the equity index. These strategies include risk arbitrage, distressed debt, convertible arbitrage, and relative value arbitrage. Consistent with the exposure of these strategies to the risks borne by sellers of equity index put options, Agarwal and Naik (2004) find that these hedge funds suffer from significant left tail risk which tends to coincide with se vere market downturns.The performance of hedge fund in 2008 was very shocking like more than ten years ago. Teo, M (2009) stated that in the month of August 1998 alone LTCM lost 45% of its capital in the wake of the massive liquidity event triggered by the Russian rubble default. Lots of academic literature has shown that the year 2007 and 2008 was the worst performance of hedge fund. As we know that hedge fund managers make portfolio by taking position in equity market and another fund, but unfortunately the world equity market goes downside. As a result investors who wish to weather future financial maelstroms should take note of the non-linear relationship between hedge fund returns and the equity market.2.3- Limitations (previous)With respect to lightly regulated investment vehicles with great treading flexibility, hedge funds often pursue highly sophisticated investment strategies. Hedge funds promise absolute returns to their investor leading to a belief that they hold factor- neutral portfolios. With this in mind, hedge funds have some limitations. In the early studies many researchers discussed and explain that obstacles.First of all if we consider the measurement model of hedge funds performance, most of the researcher use traditional performance measure model like, Sharpe ratio, Treynor ratio and Jensen alpha which are not adequate for the performance evaluation of hedge funds. Fung and Hsieh (2000) and Roy (2003) stated that is incorrect to use these performance measures t evaluate the hedge funds strategies. Brooks and Kat (2002), Kat (2003), Mahdavi (2004) and Murguia and Umemoto (2004) also mentioned that the Sharpe ratio does not represent the true performance of hedge funds because it does not take into consideration the asymmetry returns of these funds. As a result Perello (2007) propose to use the downside risk framework like Sortino ratio, the upside potential ratio and Omega measure as alternative performance measure. Moreover, Chung, Rosenb erg and Tomeo (2004) and Scherer (2004) showed that Sortino ratio makes it possible to the investors to evaluate the risk and the performance of the hedge funds more sustainably than Sharpe ratio.Secondly, according to Ackermann et al. (1999) and to Fung and Hsieh (2000), two upward biases exist in the case of hedge funds. They do not exist in the case of mutual funds, and they both have an opposite impact to the survivorship bias. Survivorship bias is an important issue in hedge funds performance studies (see Carhart and al. 2000). This bias is present when a database contains only funds that have data for the whole period studies. In this case, there is a risk of overestimating the mean performance because the funds that would have ceased to exist because of their bad performance would not be taken into account. The two upward biases exist because, since hedge funds are not allowed to advertise, they consider inclusion in a database primarily as a marketing tool. The first phenome non stressed by Ackermann and al. (1999) and called the self-selection bias is present because funds that realize good performance have less incentive to report their performance to data providers in order to attract new investors. Malkiel, B. and Saha, A. (2005) stated in their report that Databases available at any point in time tend to reflect the returns earned by currently existing hedge funds but they do not include the returns from hedge funds that existed at some time in the past but are presently not in existence (i.e., the truly dead funds) or exist but no longer report their results (the defunct funds). Unsuccessful hedge funds have difficulties obtaining new assets. Hence, they tend to close, leaving only the more successful funds in the database. But some funds stop reporting not because they are unsuccessful but because they do not want to attract new investment.The second point called instant history bias or backfilled bias (Fung and Hsieh 2000) occurs because after i nclusion a funds performance history is backfilled. This may cause an upward bias because funds with less satisfactory performance history are less likely to apply for inclusion than funds with good performance history (Capocci Daniel 2001, An analysis of hedge fund performance 1984- 2000).