Publication Type

Journal Article

Version

Publisher’s Version

Publication Date

4-2013

Abstract

We explore the diversification benefits of increasing the number of hedge funds in an investment portfolio. Conventional wisdom suggests that investors should construct a portfolio of 20 to 30 hedge funds in order to achieve a reasonably low portfolio variance. We show using Monte Carlo simulations that the marginal benefit of including an additional hedge fund in a fund portfolio diminishes significantly once the number of hedge funds increases beyond ten. Specifically, the annualized standard deviation of a fund portfolio diminishes from 16.55 percent to 7.40 percent as we increase the number of funds from one to ten. However, the standard deviation only drops by an additional 0.55 percent when we increase the number of funds to 15. Investors can crimp portfolio variance further by spreading their capital judiciously across multiple hedge fund strategies. These findings are especially relevant for investors who are transiting from indirect investments via funds of hedge funds to direct investments in single-manager hedge funds.

Keywords

hedge funds, diversification, investment portfolio

Discipline

Finance and Financial Management

Publication

Hedge Fund Insight

First Page

2-7

Publisher

BNPP Hedge Fund Centre

City or Country

Singapore

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