Hedge Fund Portfolio Selection with Fund Characteristics
Posted: 11 May 2009 Last revised: 19 Aug 2021
Date Written: July 28, 2021
Abstract
This paper examines hedge fund portfolio selection approaches in isolation and in the context of an investor’s overall portfolio. Characteristics-based portfolios that minimize risk delivers superior out-of-sample performance. For instance, a minimum variance portfolio tilting toward small funds with high alpha and strategy distinctiveness index and low systematic risk delivers an annualized Sharpe ratio of 2.03 with a maximum drawdown of 5.20%. Investors realize diversification benefits by shifting a portion of their wealth from 60-40 equity-bond portfolio to characteristics-based hedge fund portfolio. Investors recognize the attractiveness of characteristics-based portfolios, but do not target flows enough to erode their superior performance.
Keywords: hedge fund performance, portfolio optimization, fund's characteristics, share restrictions, managerial incentive
JEL Classification: G11, G12, G14, C31
Suggested Citation: Suggested Citation