Classification of Funds

81.2: Explain how funds of hedge funds can be classified according to diversification characteristics.

Hedge funds can be classified by diversification characteristics as follows:

• Return enhancer. These funds (e.g., convertible bond arbitrage funds) offer high return, but with high correlation with traditional stock and bond portfolios.

- • Risk reducer. These funds (e.g., long/short equity funds) offer low correlation with stock and bond portfolios, but with lower returns,

• Total diversifier. These funds offer high returns and low correlation with stock and bond portfolios. Global asset allocation funds are able to offer market returns with low correlations with domestic assets.

• Pure diversifier. These funds offer high negative correlation with stock and bond portfolios, but with low or negative returns. A prime example is a fund with predominandy short positions.

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