Hedge Funds

This chapter analyses the role played by hedge funds in institutional investment portfolios. The operational and functional features of these investment vehicles are investigated, with a focus on the adoption of manager remuneration schemes based on their participation in the performance achieved using the high-water mark mechanism. The option-like structure of this contractual formula may involve a potential conflict of interest between managers and investors and an inequitable allocation of incentive fees among the subscribers of the hedge fund. Despite these issues, hedge funds have become widespread in the recent past, especially with institutional investors who are attracted by the managers’ ability to control the risk and to be uncorrelated from the market trends, significantly improving the return/risk profile of the overall asset allocation. This chapter analyses, therefore, the main strategies of the hedge funds, which can be distinguished between directional and non-directional, taking into account the fact that performance measurement of the hedge fund strategies cannot ignore the inherent biases of the available databases.