The Relative Merits of Alternative Investments in Passive Portfolios

Abstract

Should optimal passive portfolios include allocations to commodities, volatility, hedge funds and private equity? What is the most attractive path to an investment in hedge funds: single manager hedge funds, fund of hedge funds (FoHF) or investable hedge fund indices (IHF)? This article addresses these questions using a methodology similar to Black-Litterman that combines views on the performance of various alternative investments with the market implied forecast for three traditional assets: bonds, equities and real estate. Assuming persistence of recent performance of alternative investments, the results indicate that it would be optimal to tilt the global market portfolio towards single manager hedge funds, commodities and private equity and away from traditional assets. The extent of the tilt depends on the degree of credibility assigned to one's views. From a methodological viewpoint, the empirical findings are dependent on both the choice of consideration set for alternative investments and the views expressed about its future performance.