The risk associated with hedge funds and hedge fund-like mutual funds can in some cases be substantially lower than that attached to common types of mutual funds. That is the conclusion of a recent Lipper Research Series report.
In order to examine how these types of funds compare with other traditional mutual funds as portfolio diversifiers, the research focused on their risk-measurement properties rather than on their activities or investing methods. The research uses the value-at-risk (VaR) measure, rather than standard deviation, to measure risk, considering the former as a superior measure where the main objective is to minimize losses.
When deciding on a correlation measure, Andrew Clark, the senior research analyst at Lipper who prepared the research, says he based his choice
on the observation that weak or nonexistent correlations can suddenly turn into strong ones as the result of a major event.
A more appropriate calculation of correlation, which the research uses as an inverse measure of diversification, may therefore be achieved using Kendall’s tau, a measure of correlation devised by the 20th century English statistician Maurice Kendall. This is preferred to other correlation measures because in extreme situations it is seen as the most appropriate way of capturing the movement from weak to strong correlation.