Correspondence: Kartik Patel, Prisma Capital Partners, Harborside Financial Center, 208 Plaza Ten, Jersey City, NJ 07311, USA. Tel: + 1 201 356 7023; Fax: +1 201 356 7010; E-mail: kpatel@Prismapartners.com

¹is a senior risk associate with Prisma Capital Partners, a fund of hedge funds. At Prisma he has been involved with building a proprietary system of risk tools used for portfolio construction, strategy allocation and for analysing individual hedge funds. He holds an M.S. in fi nancial engineering from Columbia University, M.S. in electrical engineering from University of Maryland and a B-Tech in electrical engineering from I.I.T. Bombay.

Received 20 March 2008; Revised 20 March 2008.

Abstract

We investigate the appropriate number of hedge funds to be held in a fund-of -funds portfolio with the purpose of meeting a typical benchmark mandated by institutional investors. The technique of random sampling from a universe of managers in the Credit Suisse/Tremont hedge fund index is used to generate portfolios. We use naïve diversification as well as strategy diversification methods, where the latter simulates a diversified fund-of-funds portfolio. We conclude that 40 managers are sufficient to beat the chosen benchmark.