While hedge funds-of-funds tout their diversification as a limit on risk, this is not the case, according to research by NYU Stern Finance Professor Stephen Brown and co-authors Greg Gregoriou and Razvan Pascalau of SUNY College at Plattsburgh School of Business and Economics. In extreme market conditions, the professors attest, a broadly diversified hedge fund-of-fund is actually more sensitive to risk than an average hedge fund.
“Those who market funds-of-hedge-funds promote the ability to overcome tail risk exposure by extensively diversifying their hedge fund portfolios,” Brown said. “This is a fantasy. These funds are not an insurance policy against market tail risk.”