Choosing a hedge fund in which to invest is a daunting task. Most understand the concept that past performance is not a guarantee of future success…a truly disheartening disclaimer!

For many, funds of funds have grown to be a popular means of avoiding an actual choice, although funds of funds are also burdened with a prior performance history, However,the trauma of selecting a single fund in which to invest is averted by selecting a fund of funds as one’s preferred investment vehicle.

How Does One Select a Hedge Fund

Frankly, anyone having the answer to this question would not be writing this article. More likely, they would be basking on exotic beach front property, sipping a margarita.

Many tout the importance of the Sharpe’s ratio, which quantifies the financial reward per unit of risk. Others are all about the investment strategy pursued by the fund. Many look to the largest funds, assuming that by virtue of their size, they can afford to hire the best and brightest and/or invest in the latest technology, such as algorithms, artificial intelligence and machine learning.

Also, many investor’s place great emphasis on the past performance of funds, a strategy that hasn’t panned out too well in recent history. Names will not be mentioned!

Why Is There No Sure Method?

The answer is simple…investing is less the study of finance and more the study of how people behave with money. No college or university can teach even those with the highest IQ’s how to analyze crowd behavior.

One cannot lose sight of the fact that it is people that actually affect the markets and, arguably, it is impossible to quantify people’s behavior with complex formulas that one can analyze through a spreadsheet or computer model.

Behavior is inborn, changes over time, and is difficult to measure. More to the point, people are wont to deny its existence, especially in a personal context.

Something to Consider

Can anyone point to a field of endeavor in which someone with no formal education, no relevant experience, and no discernible connections can outperform an individual with a superior education, relevant experience, the best resources, and great connections, other than investing? Will one ever read a newspaper article in which a carpenter performs a successful heart surgery or a cashier at Walgreen’s writes a software program that accurately predicts the outcome of a presidential election? Probably not! Yet success stories as outlandish as these have routinely occurr in investment.

What’s the Point?

While education, experience, resources and connections are important considerations, the hedge fund manager’s ability to understand how people behave with respect to markets is of prime importance. Unfortunately, this enviable trait is not easy to discern. Past performance, Sharpe’s ratios, investment strategies, and other fund attributes are less opaque…but not necessarily more important than the manager’s ability to understand the behavior of people and the subsequent effects of that behavior on market events.

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