Framework for Hedge Fund Return
and Risk Attribution

Abstract

This article provides a framework for hedge fund return and risk attribution through the construction of a relevant benchmark. It is shown that volatility is a source of systematic risk, volatility measures based on equity market returns are more robust, fees have averaged between one-half and one-third of total gross returns, and high explanatory power can be achieved without the use of exotic systematic risk factors. Finally, the article suggests that alpha and systematic risk loadings are best estimated when regressed on gross returns and that systematic risk exposures are multi-dimensional and effectively modeled using a four-factor model. Hedge fund performance is determined by exposure, skill, and cost. The framework presented here provides robust attribution to exposure, skill, and cost.