PT - JOURNAL ARTICLE AU - Ivilina Popova AU - David P. Morton AU - Elmira Popova AU - Jot Yau TI - Optimizing Benchmark-Based Portfolios with Hedge Funds AID - 10.3905/jai.2007.688992 DP - 2007 Jun 30 TA - The Journal of Alternative Investments PG - 35--55 VI - 10 IP - 1 4099 - https://pm-research.com/content/10/1/35.short 4100 - https://pm-research.com/content/10/1/35.full AB - Hedge funds typically have non-normal return distributions marked by significant positive or negative skewness and high kurtosis. Mean-variance optimization models ignore these higher moments of the return distribution. This article introduces a new stochastic programming model which incorporates Monte Carlo simulation and optimization to examine the effects on the optimal allocation to hedge funds given benchmark related investment objectives such as expected shortfall and semi-variance. The results show that a substantial allocation—approximately 20% to hedge funds is justified. Specifically, the return distributions of portfolios constructed using the stochastic programming model skew to the right relative to those of the optimal mean-variance portfolios, resulting in higher Sortino ratios.TOPICS: Real assets/alternative investments/private equity, portfolio construction, quantitative methods, performance measurement