Portfolio optimization under universe of hedge funds?

Question

Emerging markets are booming these days, tons of money has been exported by institutional investor to pocket handsome return.
A investment company runs 1000 of different funds some of which are exposed completely to emerging markets & other are 10% to 20%. World's know that these market are highly volatile and extremely risky but had performed well than other caps fund and indexes funds.
As an investment company, they had to manage the risk associated with these markets, so they invest millions of money in hedge funds and derivative markets. The significant question arise here is,how the fund manager of the company can optimize their portfolio under a large universe of hedge funds.

Answer 1

This is very similar to the portfolio selection problem. The way this is done is to weigh in different stocks with different weights in your portfolio. The historic returns of each individual stock is also known. The expected return can be formulated as E(r) = sum(w_i*r_i). The expected risk, which is usually denoted by the variance of the portfolio, is modelled as V = sum sum [w_i*w_j Cov(r_i,r_j)]. The fund managers need to generate whats known as an "efficient frontier" of portfolios which minimize risk for a given return or maximize return for a given risk.

This process is fairly well documented and researched. You could look up the book "Quantitative Finance" by Brealy and Myers or search online for "portfolio optimization".

Hope this helps.

Answer 2

When you speak of hedge funds, you surely know that alot of these funds enter the arenas of gold and silver stocks, mining companies and precious metals ETFs. The danger there is when the fund has invested in these shady companies in between that do not mind selling millions of dollars of "shorts" in other words selling leases on gold and silver liken to metal derivatives. The smart look to avoid this falling into a short selling outfit is to find companies like Silver Wheaton- which is not in the mining business , has very low overhead costs, but buys silver at a fixed rate contract price from mining firms at $3.90 cents an ounce, and sells it for a profit margin of 100 to 300 percent. The old rule of thumb for large fund managers has been to not put over one percent of fund investment into any one stock, but in the fast lane today when the race has a donkey running against a fine race horse I would advise putting 10 to 15 percent into a solid company with a winning no lose plan like Silver Wheaton