Stocks, Bonds, and Hedge Funds

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Abstract
What are the diversification effects of introducing hedge funds into a portfolio of stocks and bonds? In terms of skewness and kurtosis, equity and hedge funds do not combine very well. Although hedge funds significantly improve a portfolio's mean-variance characteristics, their inclusion can also be expected to lead to significantly lower skewness as well as higher kurtosis. Hedge funds do not provide a free lunch, but rather entail a definite trade-off between profit and loss potential. To have any impact on the overall portfolio, allocations to hedge funds would have to far exceed the typical 1% to 5% that many institutions typically consider.

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