The optimal allocation of institutional investors? capital to various asset classes is referred to as inter-asset or mixed-asset diversification. During the past years, the institutional interest in investments into hedge funds and real estate investment trusts has grown considerably. In general, investing into hedge funds offers diversification benefits with respect to other investment opportunities like traditional bonds or stocks: Including hedge funds promises risk reduction without loss of expected return. It has been demonstrated that this is just true when risk is defined as standard deviation, as it has long been the case in the past. As Scott and Horvarth [1980] have shown, rational investors have clear preferences for higher order moments. Unfortunately, including hedge funds and real estate investment trusts (REITs) into portfolios very often leads to lower skewness and higher excess kurtosis (e.g. Brooks [2002], Brunel [2004]) which are the exact opposite of what investors prefer. Therefore, relying on the standard deviation is dangerous. That is why we applied models that recognize higherorder moments or the whole return distribution, respectively. In particular, we amended the traditional mean-variance analysis by looking at a power-utility, Omega, and Score-value model. Moreover, we characterized three distinct investor types and three different investment horizons of 1, 3, and 5 years. Trying to obtain more general results than those we can find from historical data only, we fitted Markow switching processes to the asset returns and simulated 10,000 paths with a Monte Carlo approach. Within this design we analyzed the optimal allocations to hedge funds and REITs statically and with monthly reallocations. Our main findings are that in the static case the utility model is dominant for the 1 year horizon and the Score model for the horizons of 3 and 5 years. When the investor is allowed to reallocate monthly to respond to market developments the mean-variance model appears to be the model of first choice. In both settings hedge funds are the most dominant asset of the optimal portfolios. REITs are mainly used for diversification and added in at considerably lower rates.     «

The optimal allocation of institutional investors? capital to various asset classes is referred to as inter-asset or mixed-asset diversification. During the past years, the institutional interest in investments into hedge funds and real estate investment trusts has grown considerably. In general, investing into hedge funds offers diversification benefits with respect to other investment opportunities like traditional bonds or stocks: Including hedge funds promises risk reduction without loss of...     »