The Fund of Hedge Fund Selection Puzzle: A Pragmatic Approach to Identify the X-Factor

Serge Darolles, Mathieu Vaissié: We use the regime switching approach introduced in Pelletier (2006), and adapted by Giamouridis and Vrontos (2007) to the context of hedge fund portfolios, to design a new tactical style allocation factor.

Author(s):

Serge Darolles

DRM-Université Paris Dauphine

Mathieu Vaissie

Head of Research, Ginjer AMResearch Associate, EDHEC-Risk Institute

We then propose to leverage on this factor to identify fund of hedge fund managers who turn out to be good at capturing the upside while controlling for the downside risk. By so doing, we provide investors with a pragmatic though robust approach to address the fund of hedge fund selection puzzle. We show in the empirical analysis that funds of hedge funds showing the strongest loading on our factor outperform their peers materially. Very interestingly, we find persistence for both the highest and the lowest loadings. In the end, 11% of the funds of hedge funds in our sample systematically appear in the 1st tier.

Type: Working paper
Date: le 14/04/2014
Research Cluster : Finance

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