Portfolios of Alternative Assets

TLDR

Interest in alternative assets, especially hedge‑fund‑of‑funds and principal‑protected hedge funds, has surged among high‑net‑worth investors seeking superior risk‑adjusted returns. Incorporating hedge funds into conventional portfolios markedly improves risk‑reward performance, outpacing bonds and equities and serving as a defensive substitute for bonds and cash during equity downturns, particularly when leveraged.

Abstract

In recent years, interest in "alternative assets" has increased tremendously, driven by the eternal search for superior risk-adjusted returns. Hedge "funds of funds" and principal-protected versions of hedge funds in particular have made major inroads into portfolios of high net worth individuals and institutions with relatively liberal investment mandates. Despite questions about the appropriateness of including these products in portfolios and the allocations that such products should receive, adding such investments to conventional portfolios significantly improves risk-reward portfolio performance. Indeed, when risk-adjusted returns are considered, portfolios of hedge funds dominate investments in traditional bond and equity portfolios. Portfolios of hedge funds can be a substitute for bonds and cash as a defensive vehicle when equity prices decline, especially when hedge fund investments are leveraged.