Do Hedge Funds Belong in Taxable Portfolios?

Abstract

The authors examine the suitability of hedge funds in taxable investment portfolios. They apply standard mean-variance analysis to taxable portfolios that include hedge funds as an asset class. They first review the performance characteristics of hedge fund portfolios and then describe the problems faced by taxable investors and the tax structures available for holding assets. Third, they specifically add hedge funds to portfolios of traditional assets. Lastly, the authors provide general guidelines on the appropriate allocation to hedge funds for taxable investors. They conclude that hedge funds significantly improve portfolio efficiency for taxable investors and find that sizeable allocations are appropriate, even for conservative portfolios, though they concede that their results also show that more aggressive taxable investors should commit much less to broad hedge fund portfolios than nontaxable investors.