Hedge Funds in a Risk Allocation Framework: Part 1

Abstract

This article is the first in a two-part series. The series will discuss the innovative ways in which academics and practitioners are enhancing asset allocation methodologies in order to incorporate hedge funds. This article will begin by discussing the current practice in asset allocation work, followed by noting what unique problems occur when applying this methodology to hedge funds. Finally the article will discuss a number of leading edge solutions to these problems.

The risk allocation framework consists of the following three steps. For the universe of potential investments: 1. Identify Risk Exposures; 2. Optimize Risk Allocation; 3. Implement Investment Strategy. Part 1 of this series will discuss the first step in the risk allocation framework, identifying the risk exposures. Part 2 of this series will cover the second and third steps, optimizing the risk allocation and implementing the investment strategy.

The Part 2 of this paper can be found at http://ssrn.com/abstract=2602845.

Keywords: hedge funds, risk factors, portfolio

JEL Classification: G11, G23