Funds of Hedge Funds (eBook)

Front Cover 1
Title page 4
Copyright Page 5
Table of Contents 6
Preface and Acknowledgments 14
About the editor 16
List of contributors 18
Part One: Performance 32
1 Rank alpha funds of hedge funds 34
1.1 Introduction 34
1.2 Hedge fund data and biases 36
1.3 Factor models for hedge funds 37
1.4 Model estimation 40
1.5 Rank alpha 48
1.6 Optimizing funds of hedge funds 48
1.7 Cleaning the covariance matrix 49
1.8 Performance analysis of rank alpha portfolios 51
1.9 Conclusion 53
References 54
2 Funds of hedge funds: bias and persistence in returns 58
2.1 Introduction 58
2.2 Database 59
2.3 Methodology 60
2.4 Descriptive statistics 62
2.5 Bias analysis 62
2.6 Persistence in performance 66
2.7 Conclusion 72
References 73
3 Replication and evaluation of funds of hedge funds returns 76
3.1 Introduction 76
3.2 The KP efficiency measure 78
3.3 Evaluation results 82
3.4 Distributional analysis 84
3.5 Conclusion 86
References 87
4 Performance, size, and new opportunities in the funds of hedge funds industry 88
4.1 Introduction 88
4.2 Experimental framework 89
4.3 Factor model for fund of funds 91
4.4 Sample formation 93
4.5 Performance decomposition of FOF portfolios 95
4.6 Principal components of FOF returns 101
4.7 Conclusion 108
References 109
5 Optimal fund of funds asset allocation: hedge funds, CTAs, and REITs 110
5.1 Introduction 110
5.2 Data 112
5.3 Methodology 115
5.4 Results 119
5.5 Conclusion 126
References 127
6 The changing performance and risks of funds of funds in the modern period 130
6.1 Characteristics of funds of funds 130
6.2 Comparing returns: funds of funds vs. hedge funds 131
6.3 Ancient history vs. modern history: LTCM as the defining moment 133
6.4 Factor analysis of returns 134
6.5 The future of funds of funds 136
References 137
7 Hedge fund indices: Are they cost-effective alternatives to funds of funds? 138
7.1 Introduction 138
7.2 Funds of funds 139
7.3 Investable hedge fund indices 139
7.4 Distribution of returns and potential biases 141
7.5 Asset-based style factors 142
7.6 Mean excess return and Sharpe ratio comparisons 144
7.7 Fung and Hsieh model alphas and information ratio comparisons 144
7.8 Correlation with traditional asset returns and lagged equity return comparisons 147
7.9 Conclusion 148
References 149
8 Simple hedge fund strategies as an alternative to funds of funds: evidence from large-cap funds 150
8.1 Introduction 150
8.2 Data 152
8.3 Methodology 154
8.4 Empirical results 156
8.5 Conclusion 162
References 162
Part Two: Diversification, Selection, Allocation, and Hedge Fund Indices 164
9 Funds of funds of hedge funds: welcome to diworsification 166
9.1 Introduction 166
9.2 The art and science of diversification 167
9.3 Analysis 168
9.4 Diversification results 169
9.5 How about the fees? 173
9.6 Conclusion 174
References 174
10 Style analysis of funds of hedge funds: measurement of asset allocation and style drift 176
10.1 Introduction 176
10.2 Sharpe's model for style analysis 177
10.3 Data set 179
10.4 Hedge fund classification 180
10.5 Accuracy of Sharpe's model 189
10.6 Measuring the style drift 194
10.7 Conclusion 197
References 197
Appendix 200
11 Gains from adding funds of hedge funds to portfolios of traditional assets: an international perspective 202
11.1 Introduction 202
11.2 Data 204
11.3 Method 206
11.4 Results 209
11.5 Conclusion 215
References 217
12 Tactical asset allocation for hedge fund indices at one- to six-month horizons 220
12.1 Introduction 220
12.2 The model 225
12.3 The results 228
12.4 Conclusion 232
References 232
13 Single-strategy funds of hedge funds: How many funds? 234
13.1 Introduction 234
13.2 Decomposition 235
13.3 Conclusion 241
References 241
Part Three: Construction and Statistical Properties of Funds of Hedge Funds 242
14 Distributional characteristics of funds of hedge funds returns 244
14.1 Introduction 244
14.2 Hedge funds: background 246
14.3 Testing for normality 249
14.4 Data and summary performance information 254
14.5 Results 261
14.6 Conclusion 267
References 267
15 Funds of funds and the diversification effect 270
15.1 Introduction 270
15.2 Mean-variance spanning tests 271
15.3 Data description 275
15.4 Empirical results 275
15.5 Conclusion 279
References 280
Appendix 281
16 Higher-moment performance characteristics of funds of funds 282
16.1 Introduction 282
16.2 Performance assessment basics 283
16.3 Data and methodology 285
16.4 Performance characteristics of funds of funds 286
16.5 Enhancing FOF performance 289
16.6 Results 289
16.7 Conclusion 291
References 292
17 The market risk of funds of hedge funds: a conditional approach 294
17.1 Introduction 294
17.2 Estimation of the regimes for the core assets 297
17.3 Implications for hedge funds returns modeling 298
17.4 An application to stress testing 313
17.5 Conclusion 315
References 315
18 Revisiting the Fama and French model: an application to funds of funds using nonlinear methods 318
18.1 Introduction 318
18.2 Methodology 319
18.3 Data 320
18.4 Results 320
18.5 Conclusion 337
References 337
19 Investor's choice: an investor-driven, forward-looking optimization approach to fund of hedge funds construction 340
19.1 Introduction 340
19.2 Data set: defining market patterns 342
19.3 Methodology: investor-driven objectives and the optimization algorithm 346
19.4 Empirical analysis: exhibiting the new degrees of freedom 349
19.5 Conclusion 354
References 355
Part Four: Monitoring Risk, Overview of Funds of Funds, Due Diligence, and Special Classes of Funds of Funds 356
20 Moments analysis in risk and performance monitoring of funds of hedge funds 358
20.1 Introduction 358
20.2 Funds of hedge funds 359
20.3 Investing in funds of hedge funds: a practical approach 360
20.4 Data description, empirical analysis, and results 363
20.5 Analysis of trade-off 372
20.6 Conclusion 378
References 379
21 An overview of funds of hedge funds 380
21.1 Introduction 380
21.2 Creating a portfolio of hedge funds 381
21.3 Ongoing portfolio management 381
21.4 Returning to the problem of the individual investor 384
21.5 Tracking funds of funds 385
21.6 Conclusion 390
References 392
22 Institutional investment due diligence on funds of hedge funds 394
22.1 Introduction 394
22.2 The gap: fiduciary responsible investing vs. private client products 395
22.3 Exploring institutional fiduciary responsibility 396
22.4 Exploring fiduciary responsibility: what IBM has that the average hedge fund of funds needs to incorporate 397
22.5 Conclusion 404
References 405
23 Synthetic collateralized debt obligations (CDO) squares and the continuing evolution of funds of funds 406
23.1 Introduction 406
23.2 Development of synthetic CDO squares 407
23.3 Structure of synthetic CDO squares 408
23.4 Recharacterization risk 410
23.5 Conclusion 412
References 412
24 Natural resources funds of funds: active management, risk management, and due diligence 414
24.1 Introduction 414
24.2 Emerging demand for natural resources investments 414
24.3 Diversified, active-management opportunities in natural resources investing 415
24.4 Risk management in natural resources futures trading 419
24.5 Due diligence in natural resources fund of funds investing 423
24.6 Conclusion 429
References 430
25 Identifying and monitoring risk in a fund of hedge funds portfolio 432
25.1 Introduction 432
25.2 Diversification and overdiversification 434
25.3 Liquidity 439
25.4 Transparency 440
25.5 Factor and impact analysis 443
25.6 Conclusion 447
References 447
26 The wizardry of analytics for funds of funds 448
26.1 Introduction: If only I had good risk analytics 448
26.2 You're not in Kansas anymore 449
26.3 Click your heels and say "There's nothing like diversification" 451
26.4 We're off to see the wizard 453
26.5 The man behind the curtain 454
26.6 Follow the yellow brick road 460
26.7 Conclusion: You're never going back to Kansas 462
References 462
27 Quantitative hedge fund selection for funds of funds 464
27.1 Introduction 464
27.2 Indicators for hedge fund selection 465
27.3 Data 469
27.4 Empirical results 470
27.5 Conclusion 483
References 484
Index 486