Hedge Fund Diversification: How Much is Enough?

FAME Research Working Paper No. 52

53 Pages Posted: 31 Aug 2002

See all articles by Francois Lhabitant

Francois Lhabitant

Kedge Capital Fund Management; EDHEC Business School

Michelle Learned

Thunderbird, American Graduate School of International Management

Date Written: July 2002

Abstract

There are many benefits to investing in hedge funds, particularly when using a diversified multi-strategy approach. Over the recent years, multi-strategy funds of hedge funds have flourished and are now the favorite investment vehicles of institutional investors to discover the world of alternative investments. More recently, funds of hedge funds that specialize within an investment style have also emerged. Both types of funds put forward their ability to diversify risks by spreading them over several managers. However, diversifying a hedge fund portfolio also raises a number of issues, such as the optimal number of hedge funds to really benefit from diversification, and the influence of diversification on the various statistics of the return distribution (e.g. expected return, skewness, kurtosis, correlation with traditional asset classes, value at risk and other tail statistics). In this paper, using a large database of hedge funds over the 1990-2001 period, we study the impact of diversification on naively constructed (randomly chosen and equally weighted) hedge fund portfolios. We also provide some insight into style diversification benefits, as well as the inter-temporal evolution of diversification effects on hedge funds.

Keywords: Hedge funds, diversification

JEL Classification: G11

Suggested Citation

Lhabitant, Francois-Serge and Learned, Michelle, Hedge Fund Diversification: How Much is Enough? (July 2002). FAME Research Working Paper No. 52. Available at SSRN: https://ssrn.com/abstract=322400 or http://dx.doi.org/10.2139/ssrn.322400

Francois-Serge Lhabitant (Contact Author)

Kedge Capital Fund Management ( email )

28-30 The Parade
St Helier, JE1 1ZZ
Jersey

HOME PAGE: http://www.lhabitant.net

EDHEC Business School ( email )

393 Prom. des Anglais
Nice, 06200
France

Michelle Learned

Thunderbird, American Graduate School of International Management ( email )

15249 N 59th Ave.
Glendale, AZ 85306
United States

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