Hidden Benefits of Equal Weighting: The Case for Hedge Fund Indices

Abstract

In this paper we study statistical properties of equal-weighted indices of hedge funds. We find that aside from diversification benefits, 1/N naive equal-weighting possesses some additional attractive relative performance properties. We show that subject to certain assumptions, such an index outperforms more than half of its constituencies and provides lower risk and better risk-adjusted performance characteristics than the majority of them as well. We find that similar properties hold for equities and, to a lesser degree, for mutual funds. We relate these properties to the skewness of cross-sectional distributions of hedge fund returns. We also briefly discuss efficient implementations of the equal-weighted indices of hedge funds.