Hedge Fund and Risk-free rate benchmark

Hedge Fund

Hedge Fund	Return	St. Dev.	Beta	Maximum drawdown (*1)	Sharpe ratio (rf=4%)	Risk
Long/short equity	14.6%	9.1%	0.1	-10.3%	(14.6%-4%)/9.1% = 1.16
Fixed income arbitrage	6.0%	4.1%	0.0 (*4)	-14.4% (*2)	(6.0%-4%)/4.1% = 0.49	Leverage risk Credit spread risk
Equity market neutral	8.1%	3.2%	0.6	-9.7%	(8.1%-4%)/3.2% = 1.28
Distressed securities	12.1%	5.6%	0.4	-12.8%	(12.1%-4%)/5.6% = 1.45 (*3)
S&P 500 index	10.4%	15.5%	-	-44.7%	(10.4%-4%)/15.5% = 0.41

(*1) The largest loss from peak to trough a hedge fund experienced over a certain period. Market disruption risk.

(*2)The greatest risk (of long-tail events) if a major market disruption were to occur.

(*3) Superior investment based on the highest Sharpe ratio, a hedge fund's risk-adjusted performance.

(*4) The positive risk-free rate benchmark (e.g. USD 1M LIBOR) can be justified by the fact that arbitrage strategies should be market neutral. It should be understood that the Equity Market Neutral hedge fund manager must take on some type of risk to generate excess returns.

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Risk-free rate benchmark

• The risk-free rate benchmark can be justified by the fact that arbitrage strategies should be market neutral. A market neutral fund should earn the risk-free rate. The Equity Market Neutral hedge fund employs a strategy that is closest to generate a return greater than the risk-free rate. It should be understood that the Equity Market Neutral hedge fund manager must take on some type of risk to generate excess returns.
• Both beta and correlation (to market index) in a question could be distractors. In practice, a market neutral fund's beta and correlation to the market index tend to be almost zero. (In the table above, Beta of Equity Market Neutral is 0.6 though.)