Risk Management in a Multi-Strategy Framework

Abstract

Conventional methods of asset allocation employ a mean variance framework for allocating assets across asset classes, with the assumption of a symmetrical normal distribution of returns. However, in the context of multiple active strategies such as multi-strategy funds or fund-of-funds, three main differences arise, which necessitate an alternate allocation framework. First, it is the basic intention of active strategies to achieve non-normal positively skewed return distributions. Second, there is a very specific target return requirement, which needs to be accounted for in the selection and allocation to strategies. Finally, the objective of multi-strategy funds, to achieve excess return in any macro environment, any market environment and be relatively insulated during stress events, needs to be specifically incorporated in a strategy allocation process. This paper proposes a methodology for strategy allocation for a multi-strategy fund, which incorporates all these facets into a unified framework. We demonstrate how the allocation to strategies is an additional lever in a multi-strategy fund which enables the fund manager to maximize his probability of reaching a desired return target while managing the above aspects of multi-dimensional risk.

Keywords: omega, allocation, multi-strategy, higher moments

JEL Classification: G11