This paper from the ISMA Centre at the University of Reading examines competing, and often conflicting, hedge fund allocations in constructing a portfolio of hedge funds. The analysis shows that equity market neutral funds and global macro funds have predominant roles in optimal fund of hedge funds portfolios. Specifically, market neutral funds are risk and kurtosis reducers while global macro funds are skewness enhancers.

In this research paper, Patrick Burns runs a number of simulations testing the difficulty of achieving market neutrality. Results suggest that restrictions on the net value of the fund are particularly ineffective. A negative correlation-that is, market negativity- is proposed as a more reasonable target, both on theoretical and practical grounds.

This presentation by Roland Austrup examines the beneficial impact of adding managed futures to a portfolio of hedge funds.

This is an extensive analysis by Putnam Lovell NBF and NewRiver, Inc. of the factors that both promote and impede the institutionalization of the hedge fund industry. Among their conclusions, they project that global hedge fund assets will quadruple by 2010, to US $ 2.0 trillion.

The mandatory disclosure requirements of the Commodity Futures Trading Commission oblige CTA's to disclose as part of their performance reporting their " worst peak-to-valley drawdown ". It is also widely used for reporting hedge fund performance. This article examines the utility of this measure, and advances the view that " maximum drawdown is a poor statistic for making inferences about future reward / risk ratio or even future drawdown".

This comprehensive analysis of hedge fund indices by Noel Amenc and Lionel Martellini at the Marshall School of Business at the University of Southern California examines the composition of the various hedge fund indices, relative strengths and weaknesses, and suggests various methodogies to help build a pure style index or index of the indices for a given style.
They also present evidence of the ability of pure indices to improve benchmarking of hedge fund returns.

This article by Thomas Schneeweis and Georgi Georgiev of The University of Massachusetts examines the benefits of adding managed futures to a diversified asset portfolio.They found that managed futures do provide a source of return that is uniquely different from traditional stocks or bonds or even hedge funds.

The exhibits in the study support managed futures as a means to:

1. reduce portfolio volatility risk,

2. enhance portfolio returns in economic environments in which traditional stock and bond investment media offer limited opportunites, and

3. participate in a wide variety of new financial products and markets not available in traditional investor products

This comprehensive presentation by Michael S. Rule examines performance, risk and correlation characteristics of systematic trend following.

Systematic trend following is a macro strategy which trades futures and forward contracts in the currency, fixed income, equity and commodity markets. Trend following has had positive returns over 20 years because trends occur in virtually all markets some of the time. Trend following tends to create a long option, high upside volatility, positive skew return profile. The documented historical record of trend following indicates a positive expected return significantly greater than zero.

Of particular interest to investors whose portfolios include equities is the downside protection afforded by trend following. Trend following has a positive correlation to equity markets when the latter performs extremely well and significant negative correlation to equity markets when they decline severly. Most other hedge fund strategies, except for short selling, have had positive correlation with bear equity markets.

This working paper by Georgi Georgiev of the University of Massachusetts examines the investment benefits of real estate as a part of a diversified portfolio. The results suggest that direct real estate investment provides diversification benefits, while securitized real estate ( REIT ) does not.
The conclusion is twofold: 1. real estate returns are determined by factors different from those driving the returns of other asset classes and hence may provide diversification benefits and 2. REIT investment is an inadequate substitute for direct investment in real estate.

This article by Gildo Lungarella of Harcourt AG is an excellent overview of the world of managed futures and CTA's. Topics covered include the history of managed futures, the various investment approaches employed, return history, assets under management, portfolio diversification and correlation to equity markets.

This study by Harry Kat of The University of Reading examines the role of managed futures in portfolios of stocks, bonds and hedge funds. The researchers found that allocating to managed futures allows investors to achieve a very substantial degree of overall risk reduction at limited cost. Apart from their lower expected return, managed futures appear to be more effective diversifiers than hedge funds.

Adding managed futures to a portfolio of stocks and bonds will reduce that portfolio's standard deviation more and quicker than hedge funds will, and without the undesirable side-effects on skewness and kurtosis.

Overall portfolio standard deviation can be reduced further by combining both hedge funds and managed futures with stocks and bonds. As long as at least 45-50 % of the alternatives allocation is to managed futures, this again will not have any negative side effects on skewness and kurtosis.