A Note on the Reduction of Extreme Risks by Means of Diversification

A new study by EDHEC shows 20 % allocation to hedge funds can halve the probability of a big loss in a portfolio. (www.hedgefundsworld.com) A study by EDHEC shows that an allocation of 20 % to hedge funds can reduce a funds probability of extreme loss by 50%. (www.commodities-now.com) Using hedge funds can halve the probability of extreme loss in a portfolio, according to a new study from Edhec. (www.ipe.com) A recent EDHEC study1 on the use of hedge funds in asset-liability management has concluded that allocating 20 % to hedge funds can reduce a funds probability of extreme loss by 50%. This conclusion has received quite some attention in the media (see the above quotes for example) and many hedge fund marketers have already eagerly incorporated it in their sales pitch. The question, however, is whether it is indeed such a remarkable finding as many people seem to believe. After all, diversification reduces volatility and lower volatility means less extreme risk. What therefore needs to be shown is that the obtained reduction in extreme risk exceeds what one would normally expect from allocating 20 % to a new diversifier