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Progressively larger investments in the hedge fund lower the risk of the portfolio until somewhere between 30 percent and 40 percent of the money is invested in the alternative (in this case, the portfolio has the lowest risk when 36 percent of the money is invested in the hedge fund strategy and 64 percent is retained in stocks). The expected re- turn is also somewhat lower, so the investor must trade off the lower return versus the lower standard deviation of returns. Many times, the alternatives are simpler. If the hedge fund can produce returns similar to the stock portfolio but provides good di- versification (because it has a low correlation to stock returns), the blend of a hedge fund with stocks can produce the same or higher re- turns and lower risk. 2.18 The investor likely has risks that could be reduced by improving the diversification in the portfolio. Unless the investor is willing to sell the closely held family company, any investment in a hedge fund would probably have to be funded by selling the market portfolio. The in- vestor should study hedge funds that have weak correlations to the closely held asset, then design a portfolio to best diversify the risks of the rebalanced portfolio. 2.19 The direct investor avoids a layer of fees charged by the fund of funds. The investor can also pick the portfolio of hedge funds that works best with other assets held by the investor. The investor may be able to demand information about positions held in the hedge funds and perhaps reduce some concentration of risks that might occur if the in- vestor relies on others to select the managers. 230 HEDGE FUND COURSE ccc_mccrary_answers_225-274.qxd 10/6/04 1:47 PM Page 230 |
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