Most LPs (investors) look solely at past performance, which is faulty to begin with.
For example, if a hedge fund manager made a few trades and doubled his clients money because of an M&A deal with one of the stocks the HF owned, great, everyone is happy. The question is, can a new investor expect that kind of performance every year now? Does the HF manager think that is skill or luck? I’ve seen numerous managers how had good returns in their early days, but are out of business 10 years later.
What happened? They attracted a lot of interest early on because of their lucky performance. Investors expectations had a high bar set, year after year, their expectations were disappointed because the HF manager weren’t able to deliver stellar returns year after year, so their investors withdrew their money, the operating costs for the HF at that level couldn’t be sustained and the HF shut down.
Evaluate the process of how the HF firm picks their investments. The process determines the results.
Understand their strategy and what risks are being taken. Is all your money at risk? Is 25% of it at risk? Is 100% at risk? Long Term Capital Management was an early success story but lost $4.4b in less than 1 year and shut down abruptly.**
Review the HF past performance using standard deviation of their quarterly returns (or yearly if they have been around 10+ years) to understand where the outliers are for good/bad years. Dramatically wild returns year after year tell you performance is not consistent.