What Is the Optimal Number of Managers In a Fund of Hedge Funds
Via SSRN: I came across an interesting academic paper from State University of New York (SUNY) professors Greg Gregoriou and Razvan Pascalau. Diversification is often the mantra of hedge fund investors, but this paper suggests that the optimal number of underlying hedge funds within a fund of hedge fund portfolio may actually be as low as 6-10.
From the Abstract:
This paper investigates the level and the determinants of the optimal number of hedge fund managers in a Fund of Hedge Funds (FOFs). The paper also analyzes the impact that this level has on the performance and the volatility of returns of the typical FOF. Several important findings emerge. First, we find that the number of underlying hedge funds (HFs) included into a FOF has a negative and significant impact on the volatility of returns but less of an impact on the actual returns. However, if we properly classify the FOFs into several larger categories of interest, we find evidence that the FOFs having between 6 and 10 hedge fund managers perform the best. On average this group of FOFs has assets under management of around $200 million. Second, further evidence shows that there is a positive relationship between the size of the FOF portfolio and the lifetime of the fund. Third, several factors that influence the number of HF managers into a FOF include, but are not limited to the amount of leverage, the redemption frequency, the size of the fund, the total number of assets managed by the FOF manager, whether the fund issues a K-1 schedule for tax purposes, the currency in which the fund trades, the geographical focus, and the strategy pursued.
From the Introduction:
Many institutional investors, having no experience in hedge fund manager selection are willing to pay the additional layer of fees of owning a pre-packaged and diversified FOFs rather than setting up an in-house FOF. The number of underlying hedge fund managers in a FOF can play a primordial role in its performance and its survival. We believe this is the first paper to our knowledge that examines the optimal number of underlying hedge fund managers in FOFs. Numerous papers have stated what the optimal number of hedge fund managers in FOFs should be, but none have used an actual dataset to examine this.
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By online payday, Wednesday, December 9, 2009 @ 4:05 am
I like what I see. keep it going!