At PIMCO, we have developed a quantitative approach to hedge fund manager selection as a complement to – not a substitute for – traditional, time-intensive qualitative due diligence. Our framework is based on an econometric risk factor analysis that decomposes hedge fund manager returns into alpha and beta components. The most attractive managers exhibit statistically significant alpha and limited beta risk with only small exposures to traditional risk factors. A ranking methodology based on these criteria allows us to select hedge fund managers that significantly outperform their peers out of sample.

Our ranking methodology uses three “screens” that identify managers with the following characteristics:

  • Consistent high risk-adjusted returns across a set of relevant measures of overall risk as well as tail risk.
  • Substantial and significant statistical alpha generation over time. We define alpha as a positive return component that may be the result of superior market timing abilities, relative value/security selection, or capabilities that allow funds to access and exploit special market opportunities.
  • Limited exposures to the risk factors (“betas”) that drive volatility in multi-asset class portfolios , with only a small part of the return attributed to traditional risk factors.

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The Author

Niels K. Pedersen

Quantitative Research Analyst, Client Analytics

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Disclosures

The above information contains hypothetical examples and is for illustrative purposes only. Hypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.

The following disclosures may not include all risks related to investing in hedge fund strategies. Additionally, this material is not intended to provide, and should not be relied on for, accounting, legal, or tax advice. You should consult your tax or legal advisor regarding such matters.

General risks about hedge fund strategies: The strategies involve a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. All investments contain risk and may lose value. The strategies will not be subject to the same regulatory requirements as registered investment vehicles. The strategies may be leveraged and may engage in speculative investment practices that may increase the risk of investment loss. The strategies are not expected be restricted to track a particular benchmark. A strategy’s fees and expenses may offset its trading profits. The portfolio manager(s) are expected to have broad trading authority over a particular strategy. The use of a single adviser applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. The strategies generally involve complex tax structures and there may be delays in distributing important tax information. A substantial portion of the trades executed for certain strategies may be in non-U.S. securities and take place on non-U.S. exchanges. Certain strategies may invest in non-publicly traded securities which may be subject to illiquidity risk. Performance could be volatile; an investor could lose all or a substantial amount of its investments. Past performance is not a guarantee or a reliable indicator of future results.

The analysis reflected in this information is based upon data at time of analysis. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

PIMCO routinely reviews, modifies, and adds risk factors to its proprietary models. Due to the dynamic nature of factors affecting markets, there is no guarantee that simulations will capture all relevant risk factors or that the implementation of any resulting solutions will protect against loss. All investments contain risk and may lose value. Simulated risk analysis contains inherent limitations and is generally prepared with the benefit of hindsight. Realized losses may be larger than predicted by a given model due to additional factors that cannot be accurately forecasted or incorporated into a model based on historical or assumed data.

This material contains the current opinions of the manager but not necessarily those of PIMCO] and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.