management. Distribution of ownership among employees is another issue, since more distributed ownership helps retain key people, improving organizational stability and continuity. Track Record In addition to the analytical assessment of the investment strategy, there are a number of quantitative aspects of the fund's returns and portfolio. These include volatility, style characteristics, downside risk, and worst-case loss. Particularly interesting is whether returns and style are consistent with the strategy articulated by the hedge fund manager. If sufficient data are available, an evaluation of the return/risk trade-off offered by the hedge fund is usually performed. Expected absolute performance is important, and must be adequate to ensure the investors achieve their goals. However, looking only at absolute performance ignores the role of risk taking by the hedge fund. The prospective hedge fund investor will appraise whether the amount of return per unit of risk offered by the fund is consistent with the investment strategy and degree of leverage in the fund. The analysis of past returns raises the issue of performance persistence for hedge funds. Although a careful analysis of past returns is an important input to the decision-making process, chasing past performance has a number of pitfalls. Reviewing the year-over-year migration of hedge fund managers from one performance quartile to another helps to understand the hazard of placing too much weight on past performance. For example, there were 313 equity long/short managers with a full year of returns data in the TASS database for 1999 and 2000. Of the 78 managers in the top quartile of returns in 1999, only 14 (18 percent) were in the top-performing quartile for 2000. In fact, 35 (45 percent) of 1999's top-quartile managers ended 2000 in the bottom-performing quartile of managers in 2000, and the absolute best-performing fund in 1999 was the absolute worst-performing fund in 2000. This fund returned 334 percent in 1999 and -69 percent in 2000, for a net return over the two years of 3.5 percent. Unfortunately, an investment made at the beginning of 2000 based solely on 1999 returns would have ended badly. Hedge funds have tremendous scope to change their investment approaches. Many hedge funds have very flexible operating guidelines, allowing managers to change important characteristics of the investment strategy, including instruments traded and leverage. As well, investment strategies themselves change, as innovative new financial products make it possible to mitigate some risks while focusing more closely on others. Looking only at past performance does not incorporate these changes. Finally, as previously mentioned, hedge funds with the best track records tend to be closed to new investment. Chasing past performance may lead to frustration over lack of access to the funds with the best return histories. Figure 27.3 summarizes some of the information examined in evaluating a hedge fund's track record. This event-driven fund is compared to the S&P 500, a traditional equity market index, as well as the Tremont Event Driven peer index.