Hedge Fund Strategies, Performance & Diversification: A Portfolio Theory & Stochastic Discount Factor Approach

50 Pages Posted: 3 Jun 2019 Last revised: 18 Jun 2019

See all articles by David Newton

David Newton

University of Bath - School of Management

Emmanouil Platanakis

University of Bath - School of Management

Dimitrios Stafylas

Aston University - Aston Business School

Charles Sutcliffe

University of Reading - ICMA Centre

Xiaoxia Ye

University of Liverpool Management School

Date Written: June 17, 2019

Abstract

For 5,500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing the same data, we then consider the diversification benefits of each hedge fund strategy when combined with a portfolio of US equities and bonds. We compute the out-of-sample Black-Litterman portfolios, with Bayes-Stein, higher moments and simulations as robustness checks. All but two hedge fund strategies out-perform the market as stand-alone investments; and all but one provide significant diversification benefits. The higher is an investor’s risk aversion, the more beneficial is diversification into hedge funds.

Keywords: Hedge funds, portfolio diversification, Black-Litterman, Bayes-Stein, stochastic discount factors

JEL Classification: G11

Suggested Citation

Newton, David and Platanakis, Emmanouil and Stafylas, Dimitrios and Sutcliffe, Charles M. and Ye, Xiaoxia, Hedge Fund Strategies, Performance & Diversification: A Portfolio Theory & Stochastic Discount Factor Approach (June 17, 2019). Available at SSRN: https://ssrn.com/abstract=3388184 or http://dx.doi.org/10.2139/ssrn.3388184

David Newton

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Emmanouil Platanakis (Contact Author)

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Dimitrios Stafylas

Aston University - Aston Business School ( email )

Aston Triangle
Birmingham, B47ET
United Kingdom

Charles M. Sutcliffe

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

Xiaoxia Ye

University of Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

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