Are they useful or just too risky? Our resident hedge fund expert, Ken Stern, says the right hedge fund can reduce the overall risk in your portfolio and maybe even enhance your return - but be very careful as pitfalls abound.

There are many different criteria for quantifying risk. Some of the more common metrics - a few of which are also used in the traditional investment world - include Standard Deviation and Beta. Standard Deviation can be misleading because it doesn't discriminate between the desirable upside volatility and the downside volatility which is attractive only to short bias strategies. Beta indicates systemic risk measuring volatility relative to the overall market.

I also look at the amount of leverage used relative to the strategy being employed, the peak-to-trough drawdown and the Sharpe Ratio. Value at Risk is also a useful tool. It attempts to answer the burning question, "With a 95% or 99% confidence level, what is the most I can expect to lose over the next month or the next year?"

The Sharpe Ratio is one of the easiest numbers to find or even to calculate on your own and most hedge funds publish their Sharpe. It measures the amount of return an investment delivers relative to the amount of risk undertaken. The calculation is simple: use the fund's return to determine the excess return over the risk free rate then divide your answer by the Standard Deviation and you have the Sharpe Ratio. The problem is, Standard Deviation - which is the denominator in the equation - includes both upside and downside volatility. And while no one likes downside volatility, most of us welcome it with open arms on the upside.

The Sortino Ratio removes upside volatility from the equation, using downside Standard Deviation to highlight only the bad volatility. Sortino is useful because of the way it is determined but it is more difficult to calculate and not all funds provide this metric. Each of these measures is important on its own but when combined, they paint a more comprehensive picture of quantitative risk.