Lowering the Negative Impact of Hedge Fund Allocat

Traditionally, the addition of hedge funds in a portfolio has meant an increase in a portfolio return’s distribution skewness, which means that in the distribution of returns most of them have the probability of being lower than the mean return of the investment portfolio. According to the study, long/short equity and equity market-neutral funds are hit especially hard when the equity market goes sour, which is reason for the portfolio’s lower return and skewness.

The solution to the problem may come in the form of a fourth asset class, namely out-of-the-money put options on the Standard & Poor’s 500 stock index. Mr. Kat found that even a small allocation is enough to make a difference in a portfolio. Mr. Kat based his conclusion on the return calculations of hundreds of portfolios of different allocations to stocks, bonds, hedge funds and put strategies using data from Tremont* TASS from 1994 to 2001.

It is also more inexpensive to engage in a rolling S&P 500 put option strategy than to purchase a guaranteed hedge fund. According to Mr. Kat’s research, the option strategy never costs more than 0.85% a year. This amount can be expected to remain low in the current interest rate environment and is not prohibitively high for practitioners Mr. Kat concluded. *Tremont Advisers Inc., Rye, N.Y., is a minority investor in and strategic partner with HedgeWorld.