Investing in Hedge Funds
The term Hedge Fund now covers a very large number of different strategies. What these strategies have in common is that they seek to deliver "absolute" performance i.e. where periods of negative returns are very infrequent. If this absolute return can be achieved then hedge funds can act as a very good diversifier of a portfolio of conventional assets since they may be capable of producing positive returns in periods in which the returns from equities or bonds is negative.
While some individual hedge funds can and do provide very strong returns for prolonged periods the aim of the majority of funds of hedge funds is to provide relatively modest but very consistent monthly returns. There may, therefore, be prolonged periods when hedge funds underperform equities in rising equity markets.
We strongly recommend that the majority of clients seeking exposure to hedge funds should do so through collective funds of hedge funds. Although these collective funds add an extra layer of management fees on top of those of the underlying funds they do offer a number of significant advantages.
- Individual hedge funds often set high levels of minimum investment whereas some collective funds do not
- Individual hedge funds can impose freezes on withdrawals for prolonged periods whereas listed collective funds can be dealt every day as normal
- It is very difficult to get accurate or timely information from hedge fund managers - collective managers employ teams of researchers to do this
- Individual hedge funds may employ very high levels of financial gearing that makes them highly vulnerable if their strategic positions go wrong. Holding a collective fund with a diverse selection of managers and strategies reduces the risk of catastrophic loss
- Successful individual hedge funds may close for new business once they have reached a certain size. It may still be possible to obtain indirect exposure to such funds via collective funds
Investing in hedge funds should be considered by investors who wish to diversify conventional portfolio risk and who accept that by doing so they may dilute returns from their portfolios as the price of reduced volatility.