Financially Diversified Portfolios with Alternative Investments: The Impact of Life Settlements

Abstract

This study investigates whether the inclusion of life settlement (LS) funds in the formation of diversified portfolios contributes significantly to the mitigation of market risk and enhances portfolio performance. The authors construct efficient portfolios from approximations based on Markowitz’s portfolio theory by using LS funds in combination with fixed income and equity funds, gold, energy, and agricultural commodities. With nine funds representative of seven international financial markets, they find that LS funds are an effective approach to investment diversification, given their low correlation with the other proposed assets. Specifically, their results suggest that LS funds provide the largest diversification and risk-reduction benefit in combination with fixed income, equity, and commodities funds. The benefit is reduced, however, when the exchange rate effect is considered.