How to Evaluate a New Diversifier with 10 Simple Questions
Alternative Investment Research Centre Working Paper No. 39
18 Pages Posted: 28 Nov 2006
Date Written: December 1, 2006
In this paper we discuss a number of important questions to ask when analysing a new alternative diversifier from either a stand-alone, asset-only or asset-liability point of view. The framework is simple, but highly effective. Apart from the new diversifier's statistical properties, it emphasizes the importance of properly accounting for parameter uncertainty and illiquidity; two elements very often ignored by investors. It also shows the importance of taking the correct perspective when evaluating a new diversifier. What looks good from a stand-alone perspective need not look good in a portfolio context and vice versa. Application of the above framework to funds of hedge funds, commodities and synthetic funds underlines the advantages and disadvantages of these diversifiers and clearly points at synthetic funds as the most and funds of hedge funds as the least attractive of the three.
Keywords: Diversification, alternative investments, hedge funds, commodities, synthetic funds
JEL Classification: G11, G23
Suggested Citation: Suggested Citation