Monitoring performance

Hedge funds
Offer document

You might have heard a saying that funds are long-term investments, so you don't have to closely monitor them. Is that true?

Not really. A fund may perform well or poorly in long run due to various factors including market conditions, management performance and changes to the fund. There could be significant changes in the industry or market that the fund invests in. The fund's investment strategies or even the fund manager could be changed in accordance with the fund's constitution. Fund holdings may also change significantly over a short period of time. To know your investment, you need to monitor your fund regularly so that you may take timely action when necessary.

To effectively monitor your hedge funds and make informed investment decisions, you need timely, meaningful and useful information. Thus, authorised hedge funds are required to provide holders with regular reports.

How often will I receive information on my hedge funds?

You will receive annual, semi-annual and quarterly reports within the following time frame after the relevant reporting period of a single hedge fund or a fund of hedge funds (FoHFs). Some fund managers will also provide monthly reports to you on a voluntary basis:

Reports No. of reports for each financial year Time frame for distribution to holders
Single hedge funds FoHF's
Annual 1 4 months 6 months
Semi-annual 1 2 months 2 months
Quarterly 4 1 month 6 weeks

What will I find in semi-annual and annual reports? What will they tell me?

You will find information on the fund's financial position and its full investment portfolio at the mid-point and end of the financial year.

In annual reports, you should first check the reports from the auditors and the trustee/custodian. The auditors' report will tell you whether the accounts were prepared properly in accordance with the accounting policies. The trustee/custodian's report will tell you whether the fund manager has managed the fund in accordance with the provisions of the fund documents during the reporting period. Watch out for any special statements/irregularities in these two reports.

Other sections including management reports and financial statements are equally important to you to assess the fund's financial position.

How about quarterly reports? What should I look for?

In every quarterly report, you will find a management commentary and a portfolio review. Together, they give you qualitative and quantitative information on your hedge fund. The information may serve as indicators whether the fund has been managed in accordance with the investment objective and policies as set out in the fund documentation.

The management commentary gives you a glimpse of the fund performance during the reporting period and the market outlook. Watch out for the key determinants of the fund performance, any style drifts in the fund, the primary risk factors and any lawsuits currently faced by the fund. Analyse all these factors, consider whether they would sustain in future, and assess their potential implications to the fund.

If there were changes in key investment personnel, find out their impact on the fund's overall strategy and risk profile. Departure of the fund manager who generated the fund's past successful performance may result in a considerable impact on the fund's future performance. Make sure your hedge fund still meets your long-term investment objectives and risk tolerance level.

The portfolio review provides a regular snapshot of your investment portfolio as at the end of the reporting period:

  • Fund size and net asset value (NAV) per unit/share, and the percentage change in NAV per unit/share since the last reporting period. Pay special attention to significant changes (especially significant decline) over a short period of time and understand the reason of the changes (e.g. substantial loss/growth in the investment portfolio or massive redemption/subscription of shares by investors).
  • Amount of cash borrowings and other sources of leverage. You can have a sense of the use of leverage, and the corresponding risks. Generally, the higher the leverage, the higher the risks.
  • Amount of seed money. This indicates the level of committed investments in the fund by the fund management company and/or its connected persons. In some occasions, it may serve as an indicator of the fund management company's confidence towards the fund. Watch out for significant changes over time and examine the reason of the changes.
  • Illiquid holdings. Illiquid holdings are assets or positions that are relatively hard to value (i.e. no readily available market values). Due to the illiquid nature, values of these holdings would not be ascertained until an actual buy/sell transaction took place and any valuations prior to an actual transaction represent estimates only. In addition, it may be difficult to realise a large volume of illiquid holdings within a short period of time due to a lack of market interest. Thus, you should know the extent to which the fund invest in this kind of assets and understand how these assets are valued. In general, more illiquid holdings in the fund's portfolio indicate higher risks.
  • Concentrated exposures. You can have a better understanding of how diversified the fund is from this item. As a general rule, a more diversified portfolio means a better diversification of risks.
  • Performance and risk measures. Please refer to the section below for a further discussion on these measures.

Some performance and risk measures used by hedge funds sound a bit technical, what do they really mean?

The followings are some commonly used parameters for return and risk. They would help you to assess how well the fund performed during the reporting period, and the level of risks taken by the fund to achieve the return. While the following information may be useful for you to make investment decisions, please always bear in mind that past performance is not indicative of future performance.

Indicator What it measures What does a higher value of the indicator mean to investors?
Annual return (R)* Rate of return More desirable
Annualised standard deviation (SD)*(1) Volatility of return Higher investment risk, less desirable
Sharpe ratio (R/SD)*(2) Risk-adjusted return More desirable
Sortino ratio(3) Risk-adjusted return More desirable
Maximum drawdown*(4) Downside risk Higher investment risk, less desirable
Value at Risk (VaR)(5) Downside risk Higher investment risk, less desirable
Alpha Value added by the fund manager More desirable

Note: * Statistics that must be disclosed in quarterly reports.

  1. Standard deviation (SD) measures the dispersion of returns from the average return, i.e. the volatility of return. It can help tell you whether the fund return came from a few bursts or a steady stream.
  2. While the annual return (R) does not take into account the investment risks, the Sharpe ratio measures the rate of return "adjusted" by the investment risks, i.e. dividing annual return (R) by annualised standard deviation (SD).
  3. Sortino ratio is similar to Sharpe ratio except that instead of using SD (which measures both upside and downside deviations from the average return) as the denominator, Sortino ratio uses downside deviation which measures the variability of returns below a target return or benchmark.
  4. Maximum drawdown is the maximum percentage loss recorded during the period, calculated based on the fund's previous highest NAV.
  5. VaR is a currency-denominated measurement of the possible loss that a fund would incur over a specified period of time. Different fund managers have different calculation methods of VaR. You should understand the VaR calculation methodology adopted for your fund carefully.

In analysing the above data, you need to take into account both return and risk measures. For example, if we solely look at the annual return figures below, Fund A was much better than Fund B (20% vs 10%). But this is only one side of the story. The other side is that, to achieve the higher return, Fund A had taken a much higher level of risk than Fund B in terms of annualised standard deviation (16% vs 5%). If we compare their Sharpe ratios, Fund B had indeed achieved a 60% higher risk-adjusted return than Fund A (2 vs 1.25). That's why investors should consider both return and risk figures.


Indicator Fund A Fund B
Annual return 20% 10%
Annualised standard deviation 16% 5%
Sharpe ratio 1.25 2

In addition to return and risk measures, you also need to consider other relevant factors such as the investment strategies used by a hedge fund and your own investment needs. Different investment strategies may result in quite different risk and return profiles.

Finally, you should note that different hedge funds may use different calculation methods and definitions of performance and risk measures, which may not be totally comparable. Examine carefully the calculation bases and definitions of financial terms in the hedge fund reports before you compare data from different hedge funds. You should only compare like with like.

Remember, both qualitative information and quantitative data in the fund documentation (including the offering document and the regular reports) are important in analysing your hedge fund. If you have any doubt on the information in the hedge fund reports and/or other fund documentation, always ask your fund manager for further information or consult the professionals before making any investment decision.