Diversification benefits

To examine the role of hedge funds as part of a wider portfolio the study compares two hypothetical portfolios: one with an equal-weighted allocation to hedge funds, global stocks and bonds and one with a 60/40 asset allocation between stocks and bonds. In this case, with the equal-weighted portfolio, the Sharpe ratio rises from 0.34 to 0.53.

“Using equal-weighted hedge fund index data from 1994 to 2011, we demonstrate that an equal weighted allocation to hedge funds, stocks and bonds delivers significantly higher Sharpe ratio and lower tail risk than the institutional investor’s standard 60/40 allocation in stocks and bonds,” the study says.