Daily Hedge Fund Return
Most hedge fund companies require to mark-to-model their portfolios in order to maintain their trading book status. As most hedge fund businesses are involved in investments on hedge funds or baskets of hedge funds, that requires daily estimation of the profit and loss of the fund assets, which is typically only available in monthly intervals.
It appears reasonable to describe daily hedge fund performance based on “portfolios” or linear combinations of returns on indices, selected to provide a comprehensive spectrum of possible market exposures. Indices are designed to capture the direction and size of market movements and are generally accepted as good proxies for overall market behavior of a given sector.
These “portfolios” should be allowed to have positive or negative weights, depending on the style of the trading strategy of each fund. The problem therefore revolves around finding suitable weights (coefficients).
We have taken an approach that relies on the assumption that if a fund has a certain exposure to some combination of market factors on a monthly basis, that will also be the case for daily returns, and that daily exposures will reflect monthly ones. Note that we use the term “portfolios” only in a figurative sense here, since from the mathematical point of view there is no requirement that the weights add up to 1.
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