Analyzing Hedge Fund Indices: Portfolio Construction and Sharpe Ratio Calculation

Equal Weight Portfolio

Question 2 The following exercises are based on the hedge fund index data provided. The underlying data is from the excel sheet provided. Suppose that you were running a multi-strategy hedge fund in 2003 and you are allocating capital across various trading groups. Compute the excess return of each of the hedge fund indices and build your report based on the following analyses:

1. Define portfolio with equal weights (i.e. 1/9) using the first 9 hedge fund styles (not including the overall index called “DJCS Hedge Fund USD”). Compute the excess return of the corresponding portfolio (as the dot product of portfolio weights and excess returns of hedge funds). Finally, compute the Sharpe ratio over the early sample 1994-2003 (that you would have been aware of in 2003), the late sample 2004-2012 (the period over which your returns would be realized), and the full sample.

2. Compute another weighted average of these 9 hedge fund styles, where the weights are chosen to maximize the Sharpe ratio over the early sample (e.g., update the code we developed in class so that the objective function is the Sharpe ratio; do not use any constraint). What is the SR of this portfolio over the late sample? How does the answer compare to the equal-weighted portfolio of the previous point? Discuss the issues with portfolio optimization and what you might do about it.