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Hedge Fund Due Diligence: A Source of Alpha in a Hedge Fund Portfolio Strategy

21 Pages Posted: 30 Sep 2007 Last revised: 11 Sep 2009

Stephen J. Brown

New York University - Stern School of Business

Thomas L. Fraser

Attorney in New York City

Bing Liang

University of Massachusetts Amherst - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: January 21, 2008

Abstract

Due diligence is an important source of alpha in a well designed hedge fund portfolio strategy. It is generally understood that the high returns possible in investing in hedge funds are somewhat offset by the relative lack of transparency on operational issues. The performance of a diversified hedge fund portfolio can be enhanced by excluding those funds likely to do poorly - or fail - due to operational risk concerns. However, effective due diligence is an expensive concern. This implies that there is a strong competitive advantage 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.

Keywords: Hedge funds, operational risk, due diligence, alpha

JEL Classification: G1, G2

Suggested Citation

Brown, Stephen J. and Fraser, Thomas L. and Liang, Bing, Hedge Fund Due Diligence: A Source of Alpha in a Hedge Fund Portfolio Strategy (January 21, 2008). Available at SSRN: https://ssrn.com/abstract=1016904 or http://dx.doi.org/10.2139/ssrn.1016904

Stephen J. Brown (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0306 (Phone)
212-995-4233 (Fax)

Thomas L. Fraser

Attorney in New York City ( email )

2250 Broadway
New York, NY 10024
United States
212 799 0799 (Phone)

Bing Liang

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States

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