The Fund of Hedge Fund Selection Puzzle: A Pragmatic Approach to Identify the X-Factor

We use the regime switching approach introduced in Pelletier (2006), and adapted by Giamouridis and Vrontos (2007) to the context of hedge fund portfolios, to design a new tactical style allocation factor. We then propose to leverage on this factor to identify fund of hedge fund managers who turn out to be good at capturing the upside while controlling for the downside risk. By so doing, we provide investors with a pragmatic though robust approach to address the fund of hedge fund selection puzzle.