Hedge Fund Due Diligence: A Source of Alpha in a Hedge Fund Portfolio Strategy
Stephen J. Brown
New York University - Stern School of Business
Thomas L. Fraser
Attorney in New York City
University of Massachusetts at Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
NYU Working Paper No. FIN-07-032
Due diligence is an important source of alpha in a well designed hedge fund portfoliostrategy. It is generally understood that the high returns possible in investing in hedgefunds are somewhat offset by the relative lack of transparency on operational issues. Theperformance of a diversified hedge fund portfolio can be enhanced by excluding thosefunds likely to do poorly or fail due to operational risk concerns. However, effectivedue diligence is an expensive concern. This implies that there is a strong competitiveadvantage to those funds of funds sufficiently large to absorb this fixed and necessary cost. The consequent economies of scale that we document in funds of funds are quite substantial and support the proposition that due diligence is a source of alpha in hedge fund investment.
Number of Pages in PDF File: 21
Keywords: Hedge funds, operational risk, due diligence, alphaworking papers series
Date posted: November 13, 2008
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