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Hedge Fund Indices: Reconciling Investability and Representativity
Author(s) -
Goltz Felix,
Martellini Lionel,
Vaissié Mathieu
Publication year - 2007
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2006.00354.x
Subject(s) - hedge fund , returns based style analysis , alternative beta , portfolio , robustness (evolution) , fund of funds , market neutral , equity (law) , economics , performance fee , econometrics , open end fund , actuarial science , passive management , capital asset pricing model , factor analysis , risk–return spectrum , financial economics , finance , institutional investor , fund administration , market liquidity , corporate governance , biochemistry , chemistry , political science , law , gene
Following a growing concern among investors about the quality of hedge fund index return data, this paper addresses the question of whether designing hedge fund indices that fulfil the usual requirements (in particular representative and investable) is or not a feasible task, given a variety of features that are specific to that industry. To test whether or not investability should necessarily come at the cost of representativity, we use a well‐known methodology in the asset pricing literature based on the concept of factor replicating portfolios. Our results suggest that it is actually possible to construct representative indices based on a limited number of funds that are open to new investments, except perhaps in the case of equity market neutral strategies, provided that: i) these funds are suitably selected and ii) a portfolio is constructed with the objective of replicating the common trend in hedge fund returns for a given strategy. A range of robustness tests are performed that show that high correlation of the factor replicating portfolios with the common factor of returns for each strategy is remarkably stable with respect to modifying the number of funds in the replicating portfolio or changing the frequency of rebalancing.