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The Journal of Portfolio Management

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Primary Article

Optimal Hedge Fund Allocations

Jan-Hein Cremers, Mark Kritzman and Sébastien Page
The Journal of Portfolio Management Spring 2005, 31 (3) 70-81; DOI: https://doi.org/10.3905/jpm.2005.500356
Jan-Hein Cremers
A vice president at State Street Associates in Cambridge, MA.
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  • For correspondence: jcremers@statestreet.com
Mark Kritzman
President and CEO of Windham Capital Management, LLC, in Cambridge.
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  • For correspondence: mkritzman@windhamcapital.com
Sébastien Page
A vice president at State Street Associates in Cambridge.
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  • For correspondence: spage@statestreet.com
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Abstract

Hedge funds have return peculiarities not commonly associated with traditional investment vehicles. They are more inclined to produce return distributions with significantly non–normal skewness and kurtosis. Investor preferences may be better represented by bilinear utility functions or S–shaped value functions than by neoclassical utility functions, and mean–variance optimization is thus not appropriate for forming portfolios that include hedge funds. Portfolios of hedge funds formed using both mean–variance and full–scale optimization, given a wide range of assumptions about investor preferences, reveal that higher moments of hedge funds do not meaningfully compromise the efficacy of mean–variance optimization if investors have power utility; mean–variance optimization is not particularly effective for identifying optimal hedge fund allocations if preferences are bilinear or S–shaped; and, contrary to conventional wisdom, investors with S–shaped preferences are attracted to kurtosis as well as negative skewness.

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The Journal of Portfolio Management
Vol. 31, Issue 3
Spring 2005
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Optimal Hedge Fund Allocations
Jan-Hein Cremers, Mark Kritzman, Sébastien Page
The Journal of Portfolio Management Apr 2005, 31 (3) 70-81; DOI: 10.3905/jpm.2005.500356

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Optimal Hedge Fund Allocations
Jan-Hein Cremers, Mark Kritzman, Sébastien Page
The Journal of Portfolio Management Apr 2005, 31 (3) 70-81; DOI: 10.3905/jpm.2005.500356
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