Fund of hedge funds portfolio selection: A multiple-objective approach

Abstract

This paper develops a technique for fund of hedge funds to allocate capital across different hedge fund strategies and traditional asset classes. Our adaptation of the polynomial goal programming optimisation method incorporates investor preferences for higher return moments, such as skewness and kurtosis, and provides computational advantages over rival methods. We show how optimal allocations depend on the interaction between strategies, as measured by covariance, co-skewness and co-kurtosis. We also demonstrate the importance of constructing like for like representative portfolios that reflect the investment opportunities available to different-sized funds. Our empirical results reveal the importance of equity market neutral funds as volatility and kurtosis reducers and of global macro funds as portfolio skewness enhancers.Journal ofstrrivatives Hedge Funds © 2009 Palgrave Macmillan.