Frictional Diversification Costs: Evidence from a Panel of Fund of Hedge Fund Holdings

Juha Joenväärä, Bernd Scherer: Using FoFs’ holdings data, we analyse the diversification choices of fund of hedge fund managers. Diversification is not a free lunch. It is not available for every fund of fund.

Author(s):

Juha Joenvaara

Assistant professor, University of Oulu, Finland

Bernd Scherer, PhD

Managing Director, Deutsche Asset ManagementResearch Associate, EDHEC Business School

Instead we find a positive log-linear relation between the number of constituent funds in a fund of hedge fund (n) and the respective assets under management (aum). More precisely it takes the form: n2 ∝ AuM. This relation is consistent with the predictions from a model of naive diversification (1/n) with frictional diversification costs such as due diligence costs. Our evidence is econometrically robust across alternative specifications and explanations.

Type: Working paper
Date: le 04/01/2016
Research Cluster : Finance

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