How Many Hedge Funds Are Needed To Create A Diversified Fund Of Funds?
- Topics:
- Commercial Lending
- Tags:
- Asset Alliance,
- Deviation,
- Finance,
- Financial Services,
- Fund,
- Hedge Fund,
- Investment
- Source:
- Asset Alliance
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Overview: Hedge Funds generally seek strong absolute returns with low correlation to market indices through one of many hedging strategies. Investors have shown considerable interest in “fund-of- funds” products as an additional way to reduce volatility by diversifying across a group of hedge funds. However, many investors tend to examine the number of funds in such a product more carefully than they examine the standard deviation of each fund or the correlations between the funds. A fund-of-funds product can offer lower expected volatility by providing diversification benefits. Three variables, the number of funds, the standard deviation of each fund and the correlation of each fund, determine the expected portfolio standard deviation of a fund-of-funds. As expected, it find that the expected standard deviation of a fund-of-funds is reduced by an increase in the number of funds and it is also reduced by a decrease in the standard deviation of each fund and by a decrease in correlation coefficients. However, the findings show that incremental reductions in the standard deviation of each fund or in correlation coefficients create significantly greater diversification benefits than do increases in the number of funds. It is our opinion that a prospective fund-of-funds investor who is concerned about expected volatility should focus more carefully on the standard deviation of each fund and the correlation between each pair of funds than on the number of funds.
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Format: PDF | Size: 75KB | Date: Mar 2001 | Pages: 9
