Alpha
Alpha is a measure of the return that is not attributable to market performance or risk level of the strategy. Alpha represents the value a manager adds to the performance of the portfolio over the market. It measures the return of the manager due to his ability to provide valueadded returns to the strategy, rather than just participating in a bull market.
Beta
Beta measures the price volatility of the portfolio in comparison to a specific benchmark. A portfolio that has a beta of 1 should increase 10% when market prices increase 10%. A fund with a beta of 1.10 is expected to perform 10% better than the market in a rising market, but 10% worse in a declining market. A portfolio with a beta of less than 1.0 indicates that it is less volatile than the market or index.
Correlation
Correlation measures the extent to which the returns of two assets are related. If correlation=1 for assets A and B, then an increase of 100% in A will be matched by a 100% increase in B. On the other extreme, if correlation=1, then an increase of 100% in A will be matched by a 100% decrease in B.
Hedge Fund
A pooled investment vehicle that is privately organized, administered by investment management professionals and not widely available to the general public. Many hedge funds share a number of characteristics: they hold long and short positions, use leverage to enhance returns, pay performance or incentive fees to their managers, have high minimum investment requirements and target absolute returns. Generally, hedge funds are not constrained by legal limitations on their investment discretion and can adopt a variety of trading strategies. The hedge fund manager often has its own capital (or that of its principals) invested in the hedge fund it manages.
Market Index
An arithmetic mean of selected stocks intended to represent the behavior of the market or some component of it. Market indices are useful tools to measure performance as well as providing peer group comparisons. Several of the most widely used indices as benchmarks for performance are the S&P 500, Russell 2000, and the Lehman Bond Index.
Optimization
Investors’ objectives are to achieve high returns with low risk, but the
two issues are directly related. High returns require high risk, and low
risk means low returns. Through asset allocation, investors determine
the ratio of different asset classes by ‘optimization’ to achieve an
expected rate of return at a desired level of risk. Optimization
techniques indicate that adding alternative investments to a balanced
portfolio of stock and bonds improves the riskadjusted returns of the
portfolio.
R Squared
R Squared is a measure of the diversification of the portfolio, and indicates the extent to which fluctuations are explained by market results. A portfolio that has R2=1.0 indicates that 100% of the returns are market determined.
Risk Analysis
Investors must evaluate risk and the relationship to return. While absolute and relative returns are important, it is important to evaluate the risk element to achieve return. Most measurements of risk analysis evaluate either the potential loss of downward price movements or the volatility of price movements of the securities portfolio. Generally, risk is also referred to as volatility.
Standard Deviation
Standard deviation is a statistical measure of risk which represents the variability of returns around the mean (average) return. The lower the standard deviation, the closer the returns are to the mean (average) value. Conversely, the higher the standard deviation, the more widely dispersed the returns are around the mean (average).
Sharpe Ratio
The Sharpe ratio is a risk measure that evaluates the relationship of return and volatility. It gives investors the ability to determine how much excess return a manager can produce for the increase in risk that the investor assumes. By dividing the portfolio’s excess return, defined as the return above the risk free rate received by US Treasury bills, by the standard deviation of the portfolio, investor’s can determine the additional return per unit of risk. The higher the Sharpe ratio, the greater return per unit of risk.
Sortino Ratio
The Sortino ratio calculates downside risk with regard to a specific targeted return. This ratio is complicated by the fact that data may not exist for an extended period of declining securities prices.
