Title: Unveiling the risk profile of funds of hedge funds
Authors: Christos Argyropoulos - University of Kent (United Kingdom)
Ekaterini Panopoulou - University of Essex (United Kingdom)
Spyros Vrontos - University of Essex (United Kingdom)
Christos Argyropoulos - Lancaster University (United Kingdom) [presenting]
Abstract: Hedge funds implement complex dynamic investment strategies with option like non-linear payoffs, involving leverage and short-selling in pursue of absolute returns. Fund of funds, as portfolios of hedge funds, offer the same investment characteristics and at the same time diversify across individual hedge funds. In order to formulate portfolios of hedge funds, fund of funds managers perform their due diligence without disclosing their selection criteria, the portfolios composition and their associated risk. We compare the risk return profile of hedge funds and fund of funds in order to evaluate the added value of fund of funds in relation to the underlying hedge funds. We construct decide portfolios of hedge funds and fund of funds in order to create benchmarks of the risk return profile of both investment vehicles. In addition, we propose optimal fund of funds strategies in order to create a portfolio of hedge funds that minimizes downside risk. Our findings suggest that for the low levels of risk, hedge funds are less risky than fund of funds while they provide better average returns. On the other hand, for high levels of risk the fund of funds provide a diversification effect at the cost of significantly reduced returns. More importantly, our proposed fund of funds strategy dominates the corresponding risk returns profile of funds of funds and individual hedge funds.