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Hedge fund strategies, performance &diversification: A portfolio theory & stochastic discount factor approach

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  • Newton, David
  • Platanakis, Emmanouil
  • Stafylas, Dimitrios
  • Sutcliffe, Charles
  • Ye, Xiaoxia

Abstract

For 5500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing the same data, we then consider the diversification benefits of each hedge fund strategy when combined with a portfolio of US equities and bonds. We compute the out-of-sample Black-Litterman portfolios, with Bayes-Stein, higher moments, simulations, desmoothed data and allowance for regimes as robustness checks. All but two hedge fund strategies out-perform the market as stand-alone investments; and all but one provide significant diversification benefits. The higher is an investor’s risk aversion, the more beneficial is diversification into hedge funds.

Suggested Citation

  • Newton, David & Platanakis, Emmanouil & Stafylas, Dimitrios & Sutcliffe, Charles & Ye, Xiaoxia, 2021. "Hedge fund strategies, performance &diversification: A portfolio theory & stochastic discount factor approach," The British Accounting Review, Elsevier, vol. 53(5).
    • Handle: RePEc:eee:bracre:v:53:y:2021:i:5:s0890838921000263
    DOI: 10.1016/j.bar.2021.101000
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    Keywords

    Hedge funds; Portfolio diversification; Black-Litterman; Bayes-Stein; Stochastic discount factors;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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