Hedge Fund Portfolio Selection with Fund Characteristics

Posted: 11 May 2009 Last revised: 19 Aug 2021

See all articles by Juha Joenväärä

Juha Joenväärä

Aalto University School of Business

Hannu Kahra

Estonian Business School, Department of Economics and Finance

Mikko Kauppila

University of Oulu

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

Joenvaara, Juha and Kahra, Ari Hannu and Kauppila, Mikko, Hedge Fund Portfolio Selection with Fund Characteristics (July 28, 2021). Journal of Banking and Finance, Vol. 132, No. 17, 2021, Available at SSRN: https://ssrn.com/abstract=1402526 or http://dx.doi.org/10.2139/ssrn.1402526

Juha Joenvaara (Contact Author)

Aalto University School of Business ( email )

Finland

Ari Hannu Kahra

Estonian Business School, Department of Economics and Finance ( email )

Estonia

Mikko Kauppila

University of Oulu ( email )

P.O. Box 4600
Oulu FIN-90014, 90570
Finland

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