Key Concepts

1. The objective of performance analysis, for hedge funds, is to assess the realized performance of the managers in the context of whether they achieved the stated goals, including generating the superior performance, on the dimensions as agreed upon. Hedge funds use a variety of tools, including Jensons alpha, the information ratio, the Sharpe ratio, and portfolio returns attribution, and tests of significance.

2. Cross-sectional analysis of performance data focuses only on surviving firms and makes no adjustment for size and risk.

3. Return-based performance assessment models were refined and extended statistically and theoretically over a period of time. For example, CAPM is based on a single market factor, whereas the advanced models are based on multiple factors to explain variations in realized returns.

4. Basic assessment models account for performance by using three measures: Jensen's alpha, the information ratio, and the Sharpe ratio. Overall,, these measures estimate excess returns over risk.

5. Refinements to the basic return-based performance assessment models achieve numerous statistical and theoretical outcomes, such as valid i-test inferences, use of ex-ante knowledge to make ex-post coefficient adjustments, testing market timing skills, value added approach to returns, and multifactor returns generating models.

6. Portfolio-based performance analysis is used to determine whether the portfolio manager produced superior returns, and if so, what the sources of those returns were. Performance attribution attributes realized portfolio returns for a single time period to multiple factors, and performance analysis tests statistical significance of a time series of the attributed returns.

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