Hedge fund portfolio selection with fund characteristics

Juha Joenväärä*, Mikko Kauppila, Hannu Kahra

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper examines hedge fund portfolio selection approaches in isolation and in the context of an investor's overall portfolio. Characteristics-based portfolios that minimize risk delivers superior out-of-sample performance. For instance, a minimum variance portfolio tilting toward small funds with high alpha and strategy distinctiveness index and low systematic risk delivers an annualized Sharpe ratio of 2.03 with a maximum drawdown of 5.20%. Investors realize diversification benefits by shifting a portion of their wealth from 60 to 40 equity-bond portfolio to characteristics-based hedge fund portfolio. Investors recognize the attractiveness of characteristics-based portfolios, but do not target flows enough to erode their superior performance.

Original languageEnglish
Article number106232
Number of pages17
JournalJOURNAL OF BANKING AND FINANCE
Volume132
Early online date27 Jun 2021
DOIs
Publication statusPublished - Nov 2021
MoE publication typeA1 Journal article-refereed

Keywords

  • Fund characteristics
  • Hedge fund performance
  • Performance persistence
  • Performance predictability
  • Portfolio optimization

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