The ôWorld Seriesö of funds of hedge funds

This is an excerpt from a story that originally appeared in the May edition of AsianInvestor magazine. To learn more about the content in the magazine, please contact Stephen Tang at [email protected] or on +852 2122 5239.

Can funds of hedge funds perform, or even out-perform when compared to hedge funds?
Are fund of hedge funds returns really uncorrelated and do their drawdowns show that they do mitigate risk? Having outperformed during one year, can they repeat the feat again and again?

All these are difficult questions to answer, but if you are paying the fees for a fund of hedge funds, they are fair questions, and you definitely should want to know the answer. The market turmoil in tandem with hedge-fund blow ups is making it easier to see which funds of hedge funds are worthwhile.

So, AsianInvestor has put on its quantitative investigator's hat. We have compiled four analytic criteria that an investor can use to test a fund of funds. We then took the top 10 performing funds of hedge funds that reported into Eurekahedge in 2008 and dissected them against each of these tests, using as the relevant index benchmarks the Eurekahedge Asian hedge fund index and the MSCI Asia Pacific index.

The criteria we applied to the funds of hedge funds are as follows:

1) Can it outperform a relevant hedge fund index? (In particular in a bull market, therefore adding value by manager selection.)
2) Does the fund of funds have lower drawdowns than the chosen hedge-fund index?
3) Does the fund of funds have low correlation to the hedge-fund index plus a relevant long-only index?
4) Time -- the fourth dimension. Can the fund of funds repeat all the above consistently in multiple market environments?