Look, we’re lovers, not fighters. Never mind the claims that hedge funds are “dead as a doornail” to UHNW investors in the media recently—we have a lot of respect for the person they interviewed, and they clearly know a lot about what UHNW investors are thinking about when it comes to their wealth. We’re just a little concerned, is all. We believe the article completely misses the point about what is important for investors to understand about allocating to hedge funds, and we figure that’s probably because there isn’t enough educational content about alternative investments and diversification aimed at financial advisors and their HNW clients. 😉 Joking, of course.
It is troubling to us that private equity and certain index funds could be thought of as acceptable substitutes for the uncorrelated performance provided by many hedge fund strategies.
I gotta have more cowbell equities, baby.
It is troubling to us that private equity and certain index funds could be thought of as acceptable substitutes for the uncorrelated performance provided by many hedge fund strategies. These are not replacements, but rather, additional pieces of a well-diversified portfolio. Hedge funds offer unique benefits that just can’t be replicated by adding more equity exposure to your portfolio (public or private). Period.
Private equity funds invest directly in private companies. While they may appear to have low volatility due to smoothed valuations, private equity returns are ultimately driven by the performance of the underlying companies, which are exposed to the same economic factors as public equities. Similarly, index funds that track broad market indices like the S&P 500 are, by definition, highly correlated with the overall equity market. While they provide diversification within equities, they do not offer true diversification from equity risk.
While they provide diversification within equities, they do not offer true diversification from equity risk.
Babies, before we’re done here, y’all be wearing gold-plated diapers.
In contrast, global macro, certain relative value arbitrage, and managed futures strategies are designed to be uncorrelated to equity markets and provide important portfolio diversification. For example, global macro funds and CTAs employ futures, forwards, options, and other derivative instruments across commodity, currency, global equity, and fixed-income markets. They take both long and short positions aiming to profit from broad macro trends and market dislocations. These strategies can provide diversification from traditional asset classes due to their dynamic trading approach and ability to go both long and short, and they usually provide a level of liquidity which is not possible with most private equity offerings—often monthly or quarterly withdrawals.
[Hedge Fund] strategies can provide diversification from traditional asset classes due to their dynamic trading approach and ability to go both long and short, and they often provide a level of liquidity—often monthly or quarterly withdrawals—which is not possible with most private equity offerings.
Certainly, high fees and the potential for underperformance are valid critiques, but this is not unique to hedge funds. It’s inherent in the alternative investment industry across fund managers, including private equity, private credit, real estate, and others. This is why, as we’ve discussed before, manager selection is the most critical factor in running a successful alternative investment program. Who you select is as important as what you select.
Explore the Space
The notion that hedge funds are “dead as a doornail” or that they can be replaced by private equity and index funds in client portfolios is fundamentally flawed. These alternatives are important components of a diversified portfolio but do not offer the unique benefits of hedge funds, particularly their ability to provide uncorrelated returns, downside protection, and exposure to alternatives with a bit of liquidity. The dynamic strategies employed by hedge funds, such as global macro and relative value arbitrage, for example, are essential for achieving true diversification and reducing overall portfolio risk.
By incorporating hedge funds alongside private equity and other strategies, investors have historically been able to build more resilient and diversified portfolios.
Financial advisors and their HNW clients need to understand that hedge funds play a crucial role in a well-rounded alternative investment program. By incorporating hedge funds alongside private equity and other strategies, investors have historically been able to build more resilient and diversified portfolios. Investors who take the time to explore and understand the true value of hedge funds will find that these investments are far from obsolete. Instead, they remain a vital tool for achieving long-term financial goals and protecting wealth in an ever-changing investment landscape.
Contact us to learn how we can help you navigate the alternative investment industry successfully.
Disclaimer:
This article is for informational and educational purposes only and should not be construed as providing tax or legal advice. It does not take into account the specific investment objectives, financial situation, or particular needs of any reader. Readers should consult with their own tax, legal, and financial advisors to determine the appropriateness of any investment strategy or approach mentioned herein. Investing involves risk, including the possible loss of principal.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
