A junior analyst is preparing an investment proposal for a large and relatively conservative university endowment fund with $5bn of assets which currently has a 60/40 allocation to equities and fixed-income respectively.

The key points of the analyst's proposal are:

The endowment should replace the entire current allocation to

traditional investments with hedge funds:

o The current 60% allocation to equities should all be reallocated

to Long/Short Equity hedge funds.

o The current 40% allocation to traditional fixed income should all

be reallocated to Fixed Income Arbitrage, Convertible Arbitrage, and Distressed Debt hedge funds (13.33% in each)

To ensure diversification the $5bn should be split equally between 500 hedge funds ($10m in each).

The analyst has based his analysis on a database of funds which is free from any major biases and estimates that their proposal would have improved the Sharpe Ratio of the endowments portfolio from 0.63 to 0.78 over the past twenty-five years.

Briefly describe any issues you see with this proposal drawing on your knowledge of both the academic literature and empirical observations.