Hedge funds in strategic asset allocation (Lyxor)

March 2014

KEYWORDS: alternative investment, asset allocation, financial crisis, hedge fund infrastructure, hedge fund investor, hedge fund operation, hedge funds, Institutional Investors, strategic asset allocation


Zélia Cazalet, Ban Zheng

  • Lyxor


Total assets under management for the hedge fund industry reached an all-time high of USD 2.6 trillion in 2013. With lower expectations for traditional assets, many institutional investors, including pension funds and corporate, are lending increasing allocation to alternative assets to secure both performance and resilience for their portfolios. As a result, hedge funds are now growing faster than any other type of asset. They are expected to reach USD 3.3 trillion by 2015 with a compound annual growth rates of around 15%.

This 11th white paper looks at hedge funds from a new perspective, in the context of Strategic Asset Allocation (SAA). We see the growth of the assets managed the industry as an implicit consequence of the different approach taken with regard to hedge fund investments.

Numerous studies using pre-2008 data have shown the benefits of adding hedge funds to SAA. Hedge funds were previously considered to be a stand-alone asset which should account for a small percentage of overall portfolios. Now, in the aftermath of the financial crisis, a new paradigm has appeared: hedge funds are becoming mature investment styles exhibiting significant and persistent performance divergence both with each other and when compared to traditional assets.

As such, hedge fund strategies should be disaggregated into sensible sub-categories which should naturally migrate from a stand-alone asset into the broader equity and bond asset-mix. In this context, we propose a reassessment of the relationship between hedge fund strategies and traditional markets to introduce an updated SAA framework with hedge funds.

To highlight the above points, this paper addresses the following structural questions:

• What are the stylized facts of hedge fund performance in the post-2008 environment ?

• How should we classify hedge funds in order to better reflect their true characteristics ?

• What is the best way to integrate the new classification process into a SAA approach ?

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