Replication and Benchmarking of Hedge Funds

Abstract

The growth in the hedge fund industry during the last two decades has been accompanied by a general decline in the performance of hedge funds. Academic research on hedge funds has led to the development of a number of replication strategies that in some cases can explain a significant portion of returns generated by various hedge fund strategies. This article presents a replication methodology that is particularly suited for performance evaluation. The methodology develops two replicating portfolios such that the distribution properties of the target are matched. The first portfolio delivers the statistical properties at the lowest possible cost while the other is more expensive but delivers the same set of properties as the target. The portfolios are used to evaluate a set of managers reporting to the CISDM Database.