Abstract
This article analyzes the benefits of adding hedge fund replication products (clones) to an existing portfolio in comparison to adding actual hedge funds as represented by hedge fund indexes. The authors employ the marginal Sharpe methodology to evaluate the benefit of adding an investment to an existing long-only portfolio. The marginal Sharpe is decomposed into a return component and a diversification component, and the authors conduct separate tests on the two components and compare clones with hedge fund indexes. Hedge fund clones, which are liquid trading strategies, seem to be able to replicate the benefit stemming from the diversification component. With respect to the return component, the benefits of adding a hedge fund index to an existing portfolio are significantly higher than those obtained by the clones. However, these results are mitigated after accounting for fees and hedge fund premiums.
Published Version
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