Hedge Fund
The Illusion Of Skill: The Problem Of Evaluating Hedge Funds With Skewed Distributions
Introduction
The big problem behind thoughtful capital allocation is that there are a wide range of approaches to choose from, where each method relies upon a unique—or purportedly unique—hypothesis to extract “allocation alpha” and where such hypotheses run the gamut of investment sophistication. Nonetheless, allocators welcome countless portfolio management strategies thanks to a wide variety of well established procedures that seek to enable effective comparing and contrasting of such diversity in strategies. More so, this toolbox supposedly results in wiser allocation decisions that should outperform a naïve approach. So with so much relying on these tools, it is critical to understand them. At their core, the vast array of decision-making tools boil down to the simplest of ideas, which is the accurate measurement of risk versus reward; collectively, the pinnacle of an ideal allocation is the most reward gained per unit of risk taken, or simply, the greatest risk adjusted return.
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