Thursday, February 02, 2006


Hedge fund analysts/traders/managers talk about returns in two ways: bips and alpha.
Bips is just an easier way of saying basis points (bps). One hundred basis points is equal to one percent. So you might hear a phrase "we're down 300 basis points for the month", and this would mean they are down 3%. They also use this phrase when talking about position sizes relative to the fund's total assets. "Disney is up to 30 bps" meaning DIS makes up 0.30% of the fund's assets.

What type of returns are hedge funds shooting for?
This of course depends on the strategy. Some funds are short-only, which means they only short stocks. Other funds specialize in certain areas (distressed, etc.) while other funds remain true to the original title of a hedge fund. Basically a hedge fund was *suppose* to hedge risks, but many hedge funds these days do not follow this definition. They take on more risk for more return.
An average hedge fund might consider being up 25bps in a day a good day. I think this will give an idea about the types of returns hedge funds go for.

Alpha is a measure of return greater than a specific benchmark. If a fund is tracking the S&P and the S&P returns 5% while the fund returns 8%, they will say they generated 3% of alpha.
Alpha is key with hedge funds because this is how they justify their fees. A typical hedge fund will charge 1% of assets (not too bad), but then take 20% of the profits! So a few good years for a portfolio manager can set him/her up for life (kind of). If you have a great reputation you can charge even higher. Steve Cohen (SAC capital) is basically a legend in the business. He takes 50% of the profits! With his record of returns he can justify this and he's made his investors a ton of money.
It's all about generating that alpha!


stockdiva said...

I really enjoyed this post. I've often wondered how this side of the business works. I bet you're the envy of all of your peers who want to work in this industry. Hedge funds are the place to be right now.

Anonymous said...

actually there are too many hedge funds these days and has diminshed returns for many of them.