What If Alpha is Just Polished Beta? On Asset Allocation and Fund of Funds

Abstract

What is the appropriate level of portfolio allocation towards fund of hedge funds? The well-known core-satellite approach would give a number around 5% or 10%, fund of hedge funds being the satellite allocation. The core allocation should be given to often low-fee, passively managed, classical beta exposure like equity and bonds. The core-satellite approach, however, is patently absurd if the satellite mostly consist of beta exposure.

The aim of this article is two-folded. Firstly, we unveil the beta exposure of fund of hedge funds with the application of a standard linear replication model. Secondly, with the transparency of these replication portfolios we investigate what the role fund of hedge funds should be in an investor's portfolio.

Keywords: asset management, fund of hedge funds, hedge fund replication