Evaluating Hedge Fund Performance

CHAPTER 7

Constructing a Portfolio of Hedge Funds

A large public retirement fund recently embarked on a new program to invest in hedge funds. As is the usual practice, it hired a well-known consulting firm to analyze its investment requirements and select the managers for its billion-dollar allocation to hedge funds. The objective of the fund is to diversify away from traditional stocks and bonds, and raise the allocation to hedge fund strategies to 15 percent of its assets. In the process, it hopes to achieve its long-term return target of 8 percent, which it has failed to meet in the past five years. The fund ended up hiring five funds of funds, achieving a broad diversification across managers. But it also added three hedge funds engaged in multitudes of trading strategies and markets. Two of them are a global macro fund and a multistrategy fund; the third specializes in market neutral strategies across global markets. The fund believes that these funds will give it access to a wider range of investment opportunities, and allow the potential for high return.

At the other end of the spectrum of investors' assets, an executive working for a hedge fund organization decided to put aside $2 million for investment with hedge funds. Approaching retirement, the executive has set his objective to achieve an overall return for his portfolio to be at least 6 percent with minimal risk of losses. After several months of research and conference calls, the executive placed $300,000 with his ...