Generating Alpha Through Hedge Fund Investing: Effective Investment Template for Hedge Fund Investment
18 Pages Posted: 22 Jun 2012
Date Written: June 11, 2012
This report is a brief of the actual research and discusses two ways of asset allocation in Hedge Funds to generate alpha over the fund of hedge funds. The fund of hedge funds have fallen out of favour for investors seeking alternative investments as they have lagged the general market returns. This paper looks at TWO effective ways of allocating capital in various hedge fund strategies and discusses the various risk and return statistics over the two popular Fund of Funds Indices by Barclays and EDHEC. The Barclays and EDHEC indices have been chosen due to their availability during the research and quality of underlying data. The original paper delves in more details with breakdown of allocation across strategies (If you are an Investment Professional or academic who would like to discuss the original research, please contact me on my email address in the report with your name, professional details and your query).
One of the strategies involves allocating equal weight across all the hedge fund strategies with rebalancing. The second strategy is a risk weighted portfolio of hedge fund indices based on the variance. This report uses data for last 10 years (Jan 2002 till Apr 2012). Both the strategies have done well in comparison to fund of hedge funds (measured through performance of FOF benchmark indices). The Equal Weight Portfolio returned 91.5% over the period with annualised volatility of 5.31% while Risk Weighted Hedge Fund Portfolio returned 70% with annualised volatility of 3.41%. While the Barclays Fund of Funds Index returned 32.75% with annualised volatility of 5.43% and EDHEC Fund of Funds Index returned 43% with annualised volatility of 5.19%. That is an excess return of nearly 2 times for the Equal Weight Index with similar volatility and excess return of approximately 37% for Risk Weighted Portfolio with 1/3rd less volatility against the Barclays Fund of Funds Index. The report discusses various risk and return statistics in greater detail. The report also touches upon the superiority of the Risk Weighted Portfolio against the Equal Weighted portfolio in providing a better risk adjusted return over the whole period (See the cumulative alpha graph in the report).
Keywords: Hedge Fund, Fund of Funds, Equal Weight, Risk Weight, Alternatives
JEL Classification: G11, C50, C51, C52, D81
Suggested Citation: Suggested Citation