Hedge funds

Incorrect My long-term goal are to establish my own Hedge Fund. 

Desirable Asset Characteristics 758 HEDGE FUND PORTFOLIOS 768... 

Unfortunately, market risks have increased as the array of available investment instruments has broadened. For example, the Mexican peso crisis in 1994, the Asian currency debacle and recession beginning in 1997, the Russian debt default and the unprecedented hedge fund bail-out coordinated by the Federal Reserve Bank in 1998, and a 30% drop in the price of technology shares early in 2000 all had major repercussions for financial markets. Where is an investor to find solace in such an unfriendly and disturbing environment ... 

Where are the new opportunities to improve portfolio performance by creatively expanding the investable asset domain There are several assets that are now increasingly accepted and utilized in portfolios. The most important are hedge funds, private equity, and venture capital. Other new assets have shown the ability to improve portfolio performance but for various reasons have not yet made the leap to widespread recognition. These include inflation-protected securities and insurance-linked products. 

The primary advantage of hedge fund portfohos is that they have provided double-digit returns going back to the 1980s with very low risk. Indeed, hedge fund portfolio volatility is close to that of bonds. With much higher returns and low correlation compared with traditional asset classes, they exhibit the necessary characteristics required to enhance overall portfolio perfotmance. 

In response to recent MV studies, there has been a strong inflow of capital into hedge funds. Even some normally risk-averse institutions such as pension funds are now making substantial allocations to hedge funds. Swensen (2000) maintains that a significant allocation to hedge funds as well as other illiquid assets is one of the reasons for substantial outperformance by leading university endowment funds over the last decade. 

As in the case of hedge funds, managers are increasingly investing in private equity to improve portfolio efficiency. Although there is much less conclusive research on private equity and investing, the recent performance record of such investments is strong. 

TABLE 4 Optimum Portfolios with Hedge Funds and Conventional Assets... 

Hedge Fund Return Total Portfolio Allocation ... 

Finally, there are a number of structured derivative products often marketed as new asset classes. Such products are usually perturbations of existing assets. For example, enhanced index products are typictdly a weighted combination of exposure to a specific equities or bond class, augmented with exposure to a particular hedge fund strategy. Similarly, yield-enhanced cash substitutes with principal guarantee features are composed of zero coupon Treasuries with the residual cash invested in options or other derivatives. Such products are part hedge fund and part primary asset from an allocation perspective and are better viewed as implementation vehicles rather than incorporated exphcitly in the asset allocation. 

COMBINING MEAN-VARIANCE ANALYSIS WITH OTHER TECHNIQUES—CONSTRUCTING OPTIMAL HEDGE FUND PORTFOLIOS... 

The steps in this process are as follows. First, hedge fund returns are decomposed into two components using a reformulation of Sharpe s (1992) style analysis. Specifictilly ... 

To select the optimum MV hedge fund portfolio that produces the highest return with a target zero beta exposure to other assets, the problem is to ... 

This is the same as the standard MV model except the portfolio return takes a more complex form (21) and an additional constraint (23) is added that forces net exposure to traditional assets to zero. Also, constraint (26) forces sufficient diversification in the number of hedge funds. 

Obtaining a feasible solution for this problem requires a diverse range of beta exposures across the set of hedge funds considered for inclusion. For example, if aU equity betas for admissible hedge funds are greater than zero, a feasible solution is impossible to attain. Fortunately, this problem is alleviated by the availability of hundreds of hedge funds in which to invest. 

A significant amount of additional information is required to solve this problem compared to that needed for most MV optimizations. Not only are individual hedge fund returns, risk, and correlations necessary, but returns must also be decomposed into skill and style components. This requires a series of regressions that link each hedge fund s return to those of traditional assets. If 200 hedge funds are candidates, then the same number of regressions is necessary to estimate the a and j parameters. 

TABLE 7 Optimized Portfolios—Hedge Fund Allocations under Various Constraints... 

Agarwal, V, and Naik, N. (2000), On Taking the Alternative Route The Risks, Rewards, and Performance Persistence of Hedge Funds, Journal Of Alternative Investments, Vol. 3, No. 2, pp. 6-23. 

Fung, W., and Hseih, D. A. (1997), Empirical Characteristics of Dynamic Trading Strategies The Case of Hedge Funds, Review of Financial Studies, Vol. 10, No. 2, pp. 275-302. 

Goldman Sachs Co. and Financial Risk Management, Ltd. (1999), The Hedge Fund Industry and Absolute Return Funds, Journal of Alternative Investments, Vol. 1, No. 4, pp. 11-27. 

Lamm, R. M., and Ghaleb-Harter, T. E. (2000a), Optimal Hedge Fund Portfolios, Deutsche Asset Management research monograph, February 8. 

---