Hedge funds are alternative investments using using pooled funds that may use a number of different strategies in order to earn active return or alpha, for their investors. Active return, or Alpha is the percentage gain or loss of an investment relative to the investment’s benchmark.
An active return is the difference between the benchmark and the actual return. It can be positive or negative and is typically used to assess performance. A benchmark is a standard against which the performance of a security, mutual fund or portfolio manager can be measured. Generally, broad market and market-segment stock and bond indexes are used for this purpose.
Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Because hedge funds may have low correlations with a traditional portfolio of stocks and bonds, allocating an exposure to hedge funds can be a good diversification strategy.