Asset-Based Hedge-Fund Styles and Portfolio Diversification

Abstract:     
Asset-based style factors link returns of hedge-fund strategies to observed market prices. They provide explicit and unambiguous descriptions of hedge-fund strategies that tells us both the nature as well as the quantity of risk. Asset-based style factors are key inputs to portfolio construction and for benchmarking hedge-fund performance on a risk-adjusted basis. The model in Fung and Hsieh (2001a) and Mitchell Pulvino (2001) can be used to construct asset-based style factors. In is shown that the model in Fung and Hsieh (2001a) correctly predicted the return behavior trend-following strategies during out-of-sample periods and particularly so during stressful market conditions like September 2001.

Keywords: Hedge Fund, Style, Risk, Portfolio Diversification

JEL Classifications: G1, G10, G11, G12

Working Paper Series