Funds of Hedge Funds

Funds of Hedge Funds

Performance, Assessment, Diversification, and Statistical Properties

1st Edition - July 18, 2006

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  • Author: Greg Gregoriou
  • eBook ISBN: 9780080472829

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With about $450 billion in assets, funds of hedge funds are the most recent darling of investors. While hedge funds carry high risk for the promise of high returns they are designed for the very rich and for large institutional investors such as pension funds. A Fund of Hedge Funds (FOF) spreads investments among a number of hedge funds to reduce risk and provide diversification, while maintaining the potential for higher than average returns. Odds are that some pension fund of yours is invested heavily in these products, and more recently these FOFs have been opened to more and more individual investors in offshore jurisdictions with lower minimum entry levels. Since this is a new and extremely fast-moving financial phenomenon, academic research has just begun in earnest, and this is the first book to present rigorous academic research by some of the leading lights in academic finance, carefully analyzing the broad array of issues involved in FOFs.

Key Features

* With over $450 billion in assets, hedge funds of funds are the darling of investors
* First book to present rigorous academic research about funds of funds
* Leading lights in academic finance from around the world analyze the broad array of issues involved in funds of funds


Primary audience: Researchers and academics in Finance.

Table of Contents

  • Preface and Acknowledgments
    About the editor
    List of contributors

    Part One Performance

    1 Rank alpha funds of hedge funds
    Carol Alexander and Anca Dimitriu

    1.1 Introduction
    1.2 Hedge fund data and biases
    1.3 Factor models for hedge funds
    1.4 Model estimation
    1.5 Rank alpha
    1.6 Optimising funds of hedge funds
    1.7 Cleaning the covariance matrix
    1.8 Performance analysis of rank alpha portfolios
    1.9 Conclusion

    2 Funds of hedge funds: bias and persistence in returns
    Daniel Capocci and Georgers Hübner

    2.1 Introduction
    2.2 Database
    2.3 Methodology
    2.4 Descriptive statistics
    2.5.1 Bias analysis
    2.5.2 Survivorship bias
    2.5.3 Instant return history bias
    2.6 Persistence in performance
    2.6.1 Persistence in performance based on past performance
    2.6.2 Persistence in performance based on past risk measures
    2.7 Conclusion

    3 Replication and evaluation of fund of funds returns 1994-2005
    Harry M. Kat and Helder P. Palaro

    3.1 Introduction
    3.2 The KP efficiency measure
    3.3 Evaluation results
    3.4 Distributional analysis
    3.5 Conclusion

    4 Factor decomposition of fund of funds returns
    Jean-François Bacmann, Pierre Jeanneret, and Stefan Scholz

    4.1 Introduction
    4.2 Experimental framework
    4.3 Factor model for fund of funds
    4.4 Sample formation
    4.5 Performance decomposition of FOF portfolios
    4.6 Principal components of FOF returns
    4.7 Conclusion

    5 Optimal fund of fund asset allocation: hedge funds, CTAs and REITs
    Nicolas Papageorgiou and Alain Elkaim

    5.1 Introduction
    5.2 Data
    5.3 The methodology
    5.4 Results
    5.5 Conclusion

    6 The changing performance and factor risks of fund of funds in the modern
    Keith H. Black

    6.1 Characteristics of funds of funds
    6.2 Comparing returns: funds of funds vs. hedge funds
    6.3 Ancient history vs. modern history: LTCM as the defining moment
    6.4 Factor analysis of returns
    6.5 The future of funds of funds

    7 Hedge fund indices: are they cost-effective alternatives to fund of funds?
    Kathryn Wilkens

    7.1 Introduction
    7.2 Fund of funds
    7.3 Investable hedge fund indices
    7.4 Distribution of returns and potential biases
    7.5 Asset based style factors
    7.6 Mean excess return and Sharpe ratio comparisons
    7.7 Fung and Hsieh model alphas and information ratio comparisons
    7.8 Correlation with traditional asset returns and lagged equity return comparisons
    7.9 Conclusion

    8 Simple hedge fund strategies as an alternative to funds of funds: evidence from
    large cap funds
    Greg N. Gregoriou, Georges Hübner, Nicolas Papageorgiou, and Fabrice Rouah

    8.1 Introduction
    8.2 Data
    8.3 Methodology
    8.4 Empirical results
    8.5 Conclusion

    Part Two Diversification, Selection, Allocation and Hedge Fund Indices

    9 Funds of funds of hedge funds: welcome to diworsification
    François-Serge Lhabitant and Nicolas Laporte

    9.1 Introduction
    9.2 The art and science of diversification
    9.3 Analysis
    9.4 Diversification results
    9.5 How about the fees?
    9.6 Conclusion

    10 Style analysis of funds of hedge funds: measurement of asset allocation and style drift
    Andreas Oehler and Oliver A. Schwindler
    10.1 Introduction
    10.2 Sharpe’s model for style analysis
    10.3 Data set
    10.4 Hedge fund classification
    10.5 Accuracy of Sharpe’s model
    10.6 Measuring the style drift
    10.7 Conclusion

    11 Gains from adding funds of hedge funds to portfolios of traditional assets: An international perspective
    Niclas Hagelin, Bengt Pramborg, and Fredrik Stenberg

    11.1 Introduction
    11.2 Data
    11.3 Method
    11.4 Results
    11.5 Conclusion

    12 Tactical asset allocation for hedge fund indices at one- to six-month horizons
    Laurent Favre

    12.1 Introduction
    12.2 The Model
    12.3 The results
    12.4 Conclusion

    13 Single strategy funds of hedge funds: how many funds?
    Ryan J. Davies, Harry M. Kat, and Sa Lu

    13.1 Introduction
    13.2 Decomposition
    13.3 Conclusion

    Part Three Construction, and Statistical Properties of Funds of Hedge

    14 The distributional characteristics of fund of hedge fund returns
    Elaine Hutson, Margaret Lynch and Max Stevenson

    14.1 Introduction
    14.2 Hedge funds: background
    14.3 Testing for normality
    14.4 Data and summary performance information
    14.5 Results
    14.6 Conclusion

    15 Funds of funds and diversification effect
    Maher Kooli

    15.1 Introduction
    15.2 Mean-variance spanning tests
    15.3 Data description
    15.4 Empirical results
    15.5 Conclusion

    16 Higher-moment performance characteristics of funds of funds
    Zsolt Berenyi

    16.1 Introduction
    16.2 Performance assessment basics
    16.3 Data and methodology
    16.4 Performance characteristics of funds of funds
    16.5 Enhancing FOF performance
    16.6 Results
    16.7 Conclusion

    17 The market risk of funds of hedge funds: a conditional approach
    Florent Pochon and Jérôme Teïletche

    17.1 Introduction
    17.2 Implications for hedge funds returns modelling
    17.3 An application to stress testing
    17.4 Conclusion

    18 Revisiting the Fama and French model: An application to funds of funds using
    nonlinear methods
    Eric Dubé, Clément Gignac and François Eric Racicot

    18.1 Introduction
    18.2 Methodology
    18.3 Data
    18.4 Results
    18.5 Conclusion

    19 Investor’s choice: an investor-driven, forward-looking optimization approach to fund of hedge fund construction
    Clemens H. Glaffig

    19.1 Introduction
    19.2 The data set: defining market patterns
    19.3 The methodology: investor-driven objectives and the optimization algorithm
    19.4 Empirical analysis: exhibiting the new degrees of freedom
    19.5 Conclusion

    Part Four Monitoring Risk, Overview of FOFs, Due Diligence, and
    Special Classes of Funds of Funds

    20 Moments analysis in risk and performance monitoring of funds of hedge funds
    David K.C. Lee, Kok Fai Phoon, and Choon Yuan Wong

    20.1 Introduction
    20.2 Funds of hedge funds
    20.3 Investing in funds of hedge funds – a practical approach
    20.4 Data description, empirical analysis and results
    20.5 Analysis of trade-off
    20.6 Conclusion

    21 An overview of funds of hedge funds
    Jean Brunel

    21.1 Introduction
    21.2 Creating a portfolio of hedge funds
    21.3 Ongoing portfolio management
    21.4 Returning to the problem of the individual investor
    21.5 Tracking funds of funds
    21.6 Conclusion
    22 Institutional investment due diligence on funds of hedge funds
    John E. Dunn, III

    22.1 Introduction
    22.2 The gap: fiduciary responsible investing vs. private client products
    22.3 Exploring institutional fiduciary responsibility
    22.4 Exploring fiduciary responsibility: what IBM has that the average hedge fund of fund needs to incorporate
    22.5 Conclusion

    23 Synthetic CDO squares and the continuing evolution of funds of funds
    Paul Ali

    23.1 Introduction
    23.2 Development of synthetic CDO squares
    23.3 Structure of synthetic CDO squares
    23.4 Recharacterisation risk
    23.5 Conclusion

    24 Natural resources fund of funds: essays on active management, risk management, and due diligence
    Rian Akey, Hilary Till, and Aleks Kins

    24.1 Introduction
    24.2 Emerging demand for natural-resources investments
    24.3 Diversified, active-management opportunities in natural-resources investing
    24.4 Risk management in natural-resources futures trading
    24.5 Due diligence in natural-resources fund of fund investing
    24.6 Conclusion

    25 Identifying and monitoring risk in a fund of hedge funds portfolio
    Meredith A. Jones

    25.1 Introduction
    25.2 Diversification and over-diversification
    25.3 Liquidity
    25.4 Transparency
    25.5 Factor and impact analysis
    25.6 Conclusion

    26 The wizardry of analytics for funds of funds
    Mary Fjelstad and Leola Ross

    26.1 If I only had good risk analytics...
    26.2 You’re not in Kansas anymore
    26.3 Click your heels and say “There’s nothing like diversification…”
    26.4 We’re off to see the wizard…
    26.5 The man behind the curtain
    26.6 Follow the yellow brick road…
    26.7 You’re never going back to Kansas

    27 Quantitative hedge fund selection for fund of funds
    Stephan Joehri and Markus Leippold
    27.1 Introduction
    27.2 Indicators for hedge fund selection
    27.3 Data
    27.4 Empirical results
    27.5 Conclusion

Product details

  • No. of pages: 496
  • Language: English
  • Copyright: © Butterworth-Heinemann 2006
  • Published: July 18, 2006
  • Imprint: Butterworth-Heinemann
  • eBook ISBN: 9780080472829

About the Author

Greg Gregoriou

Greg Gregoriou

A native of Montreal, Professor Greg N. Gregoriou obtained his joint Ph.D. in finance at the University of Quebec at Montreal which merges the resources of Montreal's four major universities McGill, Concordia, UQAM and HEC. Professor Gregoriou is Professor of Finance at State University of New York (Plattsburgh) and has taught a variety of finance courses such as Alternative Investments, International Finance, Money and Capital Markets, Portfolio Management, and Corporate Finance. He has also lectured at the University of Vermont, Universidad de Navarra and at the University of Quebec at Montreal.

Professor Gregoriou has published 50 books, 65 refereed publications in peer-reviewed journals and 24 book chapters since his arrival at SUNY Plattsburgh in August 2003. Professor Gregoriou's books have been published by McGraw-Hill, John Wiley & Sons, Elsevier-Butterworth/Heinemann, Taylor and Francis/CRC Press, Palgrave-MacMillan and Risk Books. Four of his books have been translated into Chinese and Russian. His academic articles have appeared in well-known peer-reviewed journals such as the Review of Asset Pricing Studies, Journal of Portfolio Management, Journal of Futures Markets, European Journal of Operational Research, Annals of Operations Research, Computers and Operations Research, etc.

Professor Gregoriou is the derivatives editor and editorial board member for the Journal of Asset Management as well as editorial board member for the Journal of Wealth Management, the Journal of Risk Management in Financial Institutions, Market Integrity, IEB International Journal of Finance, and the Brazilian Business Review. Professor Gregoriou's interests focus on hedge funds, funds of funds, commodity trading advisors, managed futures, venture capital and private equity. He has also been quoted several times in the New York Times, Barron's, the Financial Times of London, Le Temps (Geneva), Les Echos (Paris) and L'Observateur de Monaco. He has done consulting work for numerous clients and investment firms in Montreal. He is a part-time lecturer in finance at McGill University, an advisory member of the Markets and Services Research Centre at Edith Cowan University in Joondalup (Australia), a senior advisor to the Ferrell Asset Management Group in Singapore and a research associate with the University of Quebec at Montreal's CDP Capital Chair in Portfolio Management. He is on the advisory board of the Research Center for Operations and Productivity Management at the University of Science and Technology (Management School) in Hefei, Anhui, China.

Affiliations and Expertise

School of Business and Economics, State University of New York, Plattsburgh, NY, USA

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