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This chapter aims to determine whether diversification benefits accrue from adding emerging market hedge funds (EMHFs) to an emerging market bond/equity portfolio, and subsequently whether the type of exposure hedge funds provide is justified by their fees. We use multivariate cointegration analysis to show that the advantages of adding hedge funds to balanced portfolios are limited for the three regions of Asia, Eastern Europe, and Latin America, as well as for the entire global emerging market universe. In summary, we find that emerging market hedge funds are generally redundant for diversifying long-only emerging market investment portfolios with long-term investment horizons. This result also holds when we extend our sample by the global financial crisis in 2008 and 2009 and allow for structural breaks according to the Gregory-Hansen (1996) test. Hence, even during the global financial crisis in 2008 and 2009, when risk diversification was most needed, long-term comovements between hedge funds and traditional assets is, with the exception of the Eastern European region, not disrupted. Because EMHF returns are heavily influenced by the emerging market equity and bond markets, we conclude that the “alpha fees” charged by EMHFs may not always be appropriate for the three main regions under consideration. This also holds, however, to a lesser extent, for a global diversification among hedge funds and traditional assets in emerging markets.

Purpose – This research pinpoints the limitations of conventional models for evaluating the performance of hedge funds and attempts to provide a new framework for modeling the dynamics of risk structures of hedge funds.

Methodology/approach – This chapter aims to explore how the systematic risk exposures of hedge funds vary over time and depend on exogenous variables that managers are supposed to use in their dynamic investment strategies. To achieve this, we used a Bayesian time-varying CAPM-based beta model within a state space technology.

Findings – The results showed that the volatility, term spread rate, and shocks in liquidity influence significantly on the time variation of hedge funds. Besides, the dynamics of beta indicates that the transmission channels of systematic risk are mainly the leverage levels of hedge funds and liquidity shocks.

Originality/value of chapter – These results are original because they help to explain how expected and unexpected hedge fund returns are correlated with the systematic risk factors via the beta dynamics.

Purpose – The purpose of this chapter is to present an investigation on the dynamic linkages between global macro hedge funds and traditional financial assets of developed and emerging markets.

Methodology/approach – To explore relationships among these price indices, we analyse Granger causality and vector autoregression (VAR) dynamics through impulse response functions. Besides, multivariate cointegration is used to know long-term relationships between assets and allows risk-averse investors to reduce uncertainty. Finally, a vector error correction model (VECM) provides active asset managers the opportunity to anticipate short-term price movements.

Findings – Our results show that in a Granger causality sense, we observe long- and short-term relationships between global macro hedge funds and traditional financial assets for Canada, France and Germany. This implies that opportunities for international portfolio diversification are significantly lower for countries having relationships between assets. For Canada, France and Germany, the risk-averse investors can reduce their long-term volatility by investing according to the cointegrating vector, whereas active managers can benefit from the knowledge of short-term asset price movements. The VEC Pairwise Granger causality in the short term confirms our analysis of causality according to VAR models.

Originality/value of paper – These results are original because they help the investor to understand the dynamics of the relationship between global macro hedge funds and traditional financial assets.

The author suggests an empirical model to analyze the investment style of individual hedge funds and fund of funds. This approach is based on a mixture of the style analysis approach suggested by Sharpe [1988], the factor push approach used in stress testing, and historical simulation. The parameter estimates from this model are inputs in the Value‐at‐Risk analysis for a sample of 2,934 funds over the 1994–2000 period. The in‐sample and out‐of‐sample results suggest that the proposed approach is useful and may constitute a valuable tool for assessing the investment style and risk of hedge funds.

The purpose of this paper is to examine the possibility of creating hedge funds “clones” using liquid exchange traded instruments.

Authors analyze the performance of fixed weight and extended Kalman filter generated clone portfolios (EKF) for 14 hedge fund strategies from February 2004 to September 2009. EKF approach does not indeed impose any normality constraints on the error terms which allow the filter to find the optimal recursive process by itself. Such models could adjust even faster to sudden shifts in market conditions vs a standard Kalman filter.

For five strategies out of 14, this work finds that EKF clones outperform their corresponding indices. Thus, for certain strategies, the possibility of cloning hedge fund returns is indeed real. Results should be however considered with caution.

This paper suggests that the most important benefits of clones are to serve as benchmarks and to help investors to better understand the various risk factors that impact hedge fund returns.

Rather than using fixed‐weight and rolling windows approaches (as Hasanhodzic and Lo), this work considers an extended version of the Kalman filter, a computational algorithm that better captures the time changing dynamics of hedge fund returns. Also, in order to be practical, this research considers investable factors and that the models themselves could not be constant over time.

The purpose of this paper is to examine the ability of hedge funds and funds of hedge funds to generate absolute returns using fund level data.

The absolute return profiles are identified using properties of the empirical distributions of fund returns. The authors use both Bayesian multinomial probit and frequentist multinomial logit regressions to examine the relationship between the return profiles and fund characteristics.

Some evidence is found that only some hedge funds strategies, but not all of them, demonstrate higher tendency to produce absolute returns. Also identified are some investment provisions and fund characteristics that can influence the chance of generating absolute returns. Finally, no evidence was found for performance persistence in terms of absolute returns for hedge funds but some limited evidence for funds of funds.

This paper is the first attempt to examine the hedge fund return profiles based on the notion of absolute return in great details. Investors and managers of funds of funds can utilize the identification method in this paper to evaluate the performance of their interested hedge funds from a new angle.

Using the properties of the empirical distribution of the hedge fund returns to classify them into different absolute return profiles is the unique contribution of this paper. The application of the multinomial probit and multinomial logit models in the fund performance and fund characteristics literature is also new since the dependent variable in the authors' regressions is multinomial.

In response to common criticisms on the appropriateness of mean-variance in asset allocation decisions involving hedge funds, we offer a mean-Gini framework as an alternative. The mean-Gini framework does not require the usual normality assumption concerning return distributions. We also evaluate empirically the differences in allocation outcomes between the two frameworks using historical data. The differences turn out to be significant. The evidence thus confirms the inappropriateness of the mean-variance framework and enhances the attractiveness of mean-Gini for this asset class.

This chapter describes the evolution of the Brazilian investment fund industry and the impact of domestic and international crises on investors, managers and the main types of funds offered in Brazil. In particular, it explores the effect of the subprime crisis and shows that the first wave of this crisis had very little impact, but the second wave with the collapse of Lehman Brothers did have a major impact on risk, returns and flows of the mutual fund industry in Brazil.

This case is used in Darden's course elective, Corporate Financing, and is accompanied by a teaching note for instructors and Excel spreadsheet for students. The Carlyle Group IPO case explores the circumstances leading up to the firm's IPO in May 2012. Over the past 25 years, Carlyle had grown from a fledgling private equity firm to one of the world's largest and most diversified investment firms. Carlyle had prepared extensively for the roadshow; management anticipated some tough questions. Students are asked to evaluate the extent to which Carlyle is undervalued relative to its peers. The case provides information on how to evaluate the earnings received by the public shareholders and outlines several alternative approaches to value PPEs.