Fund of Hedge Funds Portfolio Selection: A Multiple-Objective Approach

Cass Business School Research Paper

Journal of Derivatives and Hedge Funds, Vol. 15, No. 2, pp. 91-115, 2009

33 Pages Posted: 10 May 2004

See all articles by Ryan J. Davies

Ryan J. Davies

Babson College - Finance Division

Harry M. Kat


Sa Lu

ISMA Centre, University of Reading

Date Written: September 2005


This paper incorporates investor preferences for return distributions' higher moments into a Polynomial Goal Programming (PGP) optimisation model. This allows us to solve for multiple competing hedge fund allocation objectives within a mean -variance - skewness - kurtosis framework. Our empirical analysis underlines the existence of significant differences in the return behaviour of different hedge fund strategies. Irrespective of investor preferences, the PGP optimal portfolios contain hardly any allocation to long/short equity, distressed securities, and emerging markets funds. Equity market neutral and global macro funds on the other hand tend to receive very high allocations, primarily due to their low co-variance, high co-skewness and low co-kurtosis properties. More specifically, equity market neutral funds act as volatility and kurtosis reducers, while global macro funds act as portfolio skewness enhancers. In PGP optimal portfolios of stocks, bonds, and hedge funds, where equity exposure tends to be traded off for hedge fund exposure, we observe a similar preference for equity market neutral and global macro funds.

Keywords: Hedge funds, asset allocation, diversification, skewness, kurtosis, optimisation

JEL Classification: G11, G23, D81

Suggested Citation

Davies, Ryan J. and Kat, Harry M. and Lu, Sa, Fund of Hedge Funds Portfolio Selection: A Multiple-Objective Approach (September 2005). Cass Business School Research Paper. Available at SSRN:

Ryan J. Davies (Contact Author)

Babson College - Finance Division ( email )

Tomasso Hall
Babson Park, MA 02457-0310
United States
781-239-5345 (Phone)
781-239-5004 (Fax)


Harry M. Kat


No Address Available

Sa Lu

ISMA Centre, University of Reading ( email )

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

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