Does diversity of derivatives use affect fund performance? : Evidence from hedge funds and funds of hedge funds

Purpose – The purpose of this study is to investigate the benefits of using a more diverse derivative strategy of a fund in relation to their performance and risk characteristics. Design/methodology/approach – In this study, samples of 3,382 individual hedge funds and 761 funds of hedge funds are used to analyse risk in derivative strategies. Findings – The results of the study are consistent with the hypotheses that the diversity of derivatives strategy can be related to increased probability of suffering large losses and weaker performance. These awkward characteristics related to the diversity are particularly apparent for the fixed‐income arbitrage strategy. Funds of hedge funds differ from hedge funds as they are more likely to use derivatives for risk management. Originality/value – This study presents new evidence on the relation between derivative use and fund performance. In this study, a new measure of the diversity of a derivative strategy is considered, which is the number of derivatives used by a fund.