In constructing a well-balanced portfolio of investments comprising the traditional asset classes of equities, bonds, cash and property, an additional asset class, known as “alternative investments” [or “hedge funds”], will often provide useful risk diversification for the sophisticated investor.
While Hedge Funds have been available for decades, they traditionally had extremely high entry levels (between US$1 and US$5 million) and as a result were unattainable to most investors. They were private funds reserved for the very wealthy and were not sold to the general public. As a result they were not as closely regulated as Mutual Funds [Unit Trusts] which anyone could access. Hedge funds then became accessible through multi-manager portfolios with lower entry levels. In the 2008 Global Market collapse many high risk hedge funds with large internal borrowings [called “leverage”] collapsed completely.
Regulations introduced after 2008 in most jurisdictions have tightened up the control and oversight of these funds making them more transparent. Not all hedge funds are high risk, volatile investments. Most modern hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling. They use a variety of different strategies including Global Macro, Directional, Event Driven and Relative Value. Instead of investing directly in equities, bonds commodities or property listed shares, they often use technical derivatives of these investments [such as options].
By selecting a multi-manager fund with a carefully chosen blend of well-managed individual hedge funds with different investment strategies, the risk factor is lowered to conservative levels. These funds are rapidly gaining acceptance within the portfolios of endowment and pension funds, typically among the most risk averse participants in the investment world.
These are some of the key benefits of multi-manager hedge funds: –
- Lower volatility;
- Lower risk and higher returns;
- Little or no correlation with equity and bond markets; and
- The fact that they target consistent and positive returns regardless of whether the underlying markets are rising or falling.
It is interesting to note that several traditional multi-asset Mutual Funds [Unit Trusts] now incorporate some of the strategies used in Hedge Funds to reduce volatility and improve the consistency of their returns. We believe that Hedge Funds can complement the traditional asset classes in a well balanced portfolio.