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EDHEC contests FRR decision to exclude hedge funds from strategic allocation


The FRR (Fonds de Réserve pour les Retraites) is to exclude hedge funds from its initiative to diversify its investments through the use of alternative products.

The FRR announced its intentions earlier this month citing the risky nature of the current composition of the fund, which is dominated by two asset classes - stocks and bonds - as the motivating factor behind the move. The allocation to alternative products targeted by FRR is part of a diversification logic - by being exposed to different risk factors (ie different asset classes) the portfolio's sensitivity to a given source of risk is reduced. This aims to generate returns that present greater stability over time.

By excluding hedge funds from this process, the FRR has chosen instead to concentrate this 'alternative' allocation on commodities, real estate and private equity.

The FRR justifies the exclusion of hedge funds through three main arguments. First of all, the risk/return profile of hedge funds is allegedly unsatisfactory. Secondly, the data displayed by hedge funds through their representative indices is biased. And finally, the diversification potential of hedge funds is unattractive and does not allow the efficient frontier of the portfolio held, to be improved.

EDHEC believes that these arguments are in fact symptomatic of the freely circulating conventional wisdom against hedge funds, and that they reveal a lack of familiarity with the diversification potential presented by hedge funds.

In a document entitled: 'Comments from the EDHEC Risk and Asset Management Research Centre on the decision by the FRR (Fonds de Réserve pour les Retraites) to exclude hedge funds from its strategic allocation', EDHEC shows that these arguments are not valid when they are put to the test of the numerous empirical results obtained on the basis of methods that are appropriate for the specific characteristics of hedge funds.

In response to the FRR, EDHEC specifies that:

  • hedge funds present attractive risk-adjusted performance, even if the last few years are taken into account;
  • the survivorship bias mentioned by the FRR does not cast doubt upon the usefulness of hedge fund investment; there are supports such as the EDHEC Alternative Indexes that have very limited biases and enable the usefulness of hedge funds in asset allocation to be qualified;
  • hedge funds allow portfolio diversification to be improved and, in the case of an institutional investor, the risk of asset-liability deficits to be reduced.

EDHEC believes that the reasons behind the FRR's decision to exclude hedge funds from its strategic allocation contradict the empirical results, and the expression of this opinion is prejudicial for the market if the counter-verities that it is conveying are considered.

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