Are hedge funds an attractive investment opportunity for a Norwegian private investor?

Abstract

A recent Norwegian legislative proposal, likely to become law in 2014, suggests that hedge funds should be able to approach non-professional, private investors. In light of this, the objective of our thesis is to examine if hedge funds are an attractive investment opportunity for a Norwegian private investor. By defining two sub-questions, we use empirical research and relevant academic literature to study several aspects of hedge funds. Based on the Sharpe ratio and the Modified Sharpe ratio, we find support for hedge funds providing an attractive risk/reward relationship. However, these performance evaluations are insufficient due to the illiquidity of hedge funds, the leverage risks, and the returns biases. As the efficient frontiers of stocks and bonds improve when hedge funds are included, one can argue that hedge funds provide unique returns. However, the non-normality, skewness, and kurtosis may distort the efficient frontiers. In addition, the calculated correlations between hedge funds and traditional assets, as well as the similarities between the payoff structure of hedge funds and short put options, indicate that hedge funds are not providing unique exposure. In total, our recommendation for Norwegian private investors is to be cautious with regards to investing in hedge funds. This is due to the fact that the performance of hedge funds may be distorted, the risk management features may be lower than expected, and hedge funds will likely be an expensive way of obtaining an unattractive payoff structure.