Alternative Metrics

Abstract

Although assets invested in hedge funds have grown steadily in recent years there still does not exist a consensus allocation framework among institutional investors. Despite the generally acknowledged, beneficial risk and returns characteristics of hedge funds, both its costs as well as its benefits have recently come under scrutiny. As a result and given the numerous complexities of hedge funds, there is little consensus on an allocation methodology. Yet the need for an asset allocation framework is rising given the projected growth in demand for hedge funds. This article proposes a new allocation methodology through a reversal of perspectives. Rather than centering the question of optimal allocation to hedge funds on alphas and betas, a policy-centric question of what function can be mandated to hedge funds to better achieve policy goals is framed. This is shown to lead to two new allocation building blocks and active management benchmarks: the policy return invariants and the policy risk invariants.