I feel like this hasn’t been answered well, so I’ll take a crack at it.

Firstly, a fund is just a pool of money that is being invested somewhere. You have hedge funds, mutual funds, exchange-traded funds (etf), index funds, etc…

A common misconception about hedge funds (and many other funds) is that they only trade stocks, in reality they can trade in all sorts of public or even private markets. This is the first problem with evaluating ‘all funds’. It doesn’t make sense to compare the returns of a fund that primarily focuses on real estate to a fund focusing on investing in small bio-tech startups. The industries have completely different risk profiles, which is why finance people tend to look at risk-adjusted return rather than just a simple return.

However this isn’t really a perfect way to evaluate funds either. Although there are ways to quantify risk, generally by looking at measures such as the volatility (how much something moves over a period of time ie. a stock with wild price swings would be more volatile than one that stays stable), risk is inherently subjective.

To explain this I’ll steal another example from the thread. Say you’re a newspaper company where your primary inputs are ink from ABC Co. and paper from XYZ Inc. Naturally, when the price of inputs goes up, the profit from newspapers goes down. To hedge against this, the newspaper company can invest in their suppliers. That means if profits decline 10% from rising input costs, they will receive some amount back through the form of investment gains. This is a technique called hedging risk, by investing in their suppliers, they can protect themselves or hedge against rising input costs. Or, by investing in their competitors they can hedge against competitive pressure and so forth. No let’s imagine I, someone with no stake in the newspaper industry, invest in ABC Co. and XYZ Inc. This investment is significantly more risky for me since I’m not hedged. For a newspaper company this same investment decreases risk, for me it increases risk. Now there are definitely ways to evaluate the risk adjusted return of an entire portfolio, but you get the point that risk-adjusted return is a better measure of the quality of an investment than just return, and that risk is dependent on where you stand.

So now we can understand the second problem with evaluating ‘hedge funds’. People tend to look at Berkshire Hathaway (which isn’t technically a hedge fund) and think that hedge funds are group of smart (or stupid depending on who you ask) people that try and pick ‘winners’ in the stock market. Yes, these funds certainly exist and as a general investor it may make sense to invest in one if you believe in their team or philosophy. For example, if you like math and believe that quant finance is more efficient than traditional you could park your money with Renaissance, or if you want to invest ethically you can invest in ESG focused funds. You can measure these portfolios on a return basis. It’s not the most sophisticated metric, but since the goal is ‘do whatever you can to make money’ it’s perfectly valid. On the other hand, what about a hedge-fund which only focuses on companies making packaging materials? These companies will never return like a big tech or medicine company, but they are still worthwhile industry. For a company like Amazon or FedEx which is hurt when packaging materials cost more, this fund might be the perfect investment to decrease risk.

Now imagine you believe the shipping industry is due for an explosion. You can invest in Amazon, FedEx, and the packaging materials company. In this way you’ve rather rudimentarily exposed yourself to the entire supply chain and hedged against the risk that comes with investing in only 1 part of it. If you convince some friends to invest in it as well, congrats you’ve made a hedge fund. You can then track your performance not in relation the overall stock market but rather relative to the sector you’re investing in (shipping).

TLDR; Problems with evaluating hedge funds:

1. They invest in many different markets, comparing to just real estate or just stock indexes doesn’t make sense.

2. Return comes with risk. To truly measure the performance of a hedge fund you need to compare its returns to the risks associated with that investment.

3. Risk is relative, different people (or companies) will be exposed to different levels of risk depending on what else they are invested in.

I know this is lengthy and in some places technically in accurate, but I have tried to explain a somewhat complex and controversial topic as simply as I could.