Non-Normal Return Distribution

Hedge fund returns do not approximate to normal distributions, thus popular portfolio risk measures (which assume a normal distribution) are inappropriate e.g. Sharpe ratio. Furthermore, the empirical probability distribution of monthly returns for hedge and mutual funds differ significantly. The reason for a non-normal return distribution is a result of the di-verse trading strategies employed by hedge funds. Mutual funds engage in buy-and-hold strategies whereas hedge funds engage in much shorter term trading strategies.

Secondly, hedge funds apply substantial leveraging, whereas mutual funds have limited or strict regulation on leveraging. Additionally, the relatively regulation-free investment environment of hedge funds leads to complex management strategies and high performance incentives -these all affect hedge fund returns.

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