Hedge fund strategies, performance &diversification: A portfolio theory & stochastic discount factor approach

For 5500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing same data, then consider diversification benefits each fund strategy when combined with portfolio US equities and bonds. We compute out-of-sample Black-Litterman portfolios, Bayes-Stein, higher moments, simulations, desmoothed data allowance for regimes as robustness checks. All but two out-perform market investments; all one provide significant benefits. The is an investor’s risk aversion, more beneficial into funds.