Active style allocation can add significant value to a hedge fund portfolio according to new research by the EDHEC Risk and Asset Management Research Centre.
The research paper, 'Investing in Hedge Funds: Adding Value through Active Style Allocation Decisions', by Lionel Martellini, Mathieu Vaissié and Volker Ziemann, shows that significant value can be added in a hedge fund portfolio through the systematic implementation of active style allocation decisions, both at the strategic and tactical levels.
The EDHEC researchers have extended the well-known Black-Litterman approach to show that when one has views on hedge fund performance, one can make both strategic and tactical style allocation decisions.
The paper shows that:
• An approach by selecting strategies in line with the investor's existing assets is always better than an approach with standalone funds of funds and no consideration for the investor's current investments;
• A disciplined approach to bets on returns by strategy contributes added value in addition to fund picking, which is the traditional value-added of funds of hedge funds, there is room for new value-added strategies by selecting and managing betas well.
Given the low allocation typically made to alternative investment strategies (ie generally 5 per cent to 15per cent of the global allocation), investors must try to maximise the benefits of their hedge fund portfolios. This paper shows that this can be done by customising an optimal hedge fund portfolio and by taking into account the investor's original allocation to stocks and bonds.
This research paper is one of many that will be discussed with institutional investors and hedge fund industry professionals at the EDHEC Hedge Fund Days at The Brewery in London on 15 and 16 February 2006.
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