Essays in hedge fund replication, evaluation and synthetic funds
In this thesis it is developed and demonstrated the workings of a copula-based technique that allows the derivation of dynamic trading strategies, which generate returns with statistical properties similar to hedge funds. It is shown that this technique is not only capable of replicating fund of funds returns, but is equally well suited for the replication of individual hedge fund returns. Since replication is accomplished by trading futures on traditional assets only, it avoids the usual drawbacks surrounding hedge fund investments, including the need for extensive due diligence, liquidity, capacity, transparency and style drift problems, as well as excessive management fees. This replication technique is also used to evaluate the net-of-fee performance of 875 funds of hedge funds and 2073 individual hedge funds, up to an including November 2006. Comparing fund returns with the returns on dynamic futures trading strategies with the same risk and dependence characteristics, no more than 18.6% of the funds of funds and 22.5% of the individual hedge funds in the data sample convincingly beat the benclunark. Besides the replication and evaluation of funds which already exist in the market, this technology can also be used to create new funds with previously unavailable return characteristics, the so-called `synthetic funds'. In a set of four out-ofsample tests over the period January 1998 - February 2007, it is shown that the replication-based strategies are indeed capable of accurately generating returns with a variety of properties, including negative correlation with stocks and bonds and high positive skewness. The synthetic funds also produce impressive average excess returns. Disappointing performance is leading hedge fund investors to look for cheaper alternatives to invest, such as indices of hedge funds. Unfortunately, investable hedge fund indices are nothing more than funds of funds in disguise, with performance similar or even worse than real funds of funds. The replication technology generates returns with statistical properties very similar to those of hedge fund indices, and a higher average return for most hedge fund categories, but without actually investing in hedge funds.
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