Hedge funds – Feature
Investors are increasing their allocations to low- beta hedge funds that can achieve high-single- digit returns.
Marlin Naidoo, BNP Paribas A complex asset
A big stumbling block for some investors is that hedge fund strategies can be complex and involve a variety of public and private assets as well as derivatives. This complexity can poten- tially add unique risks such as liquidity, transparency and lev- erage, as well as paying incentive fees, many of which are not usually
present in traditional equity and fixed income
investments. “When investing in hedge funds, investors should consider whether the added complexity is worth the diversification ben- efit that a hedge fund brings to the overall portfolio,” McGuane adds. “Secondly, investors should consider potential customi- sation options available in structuring a hedge program, given the mandate size and program goals.”
Investors use hedge funds for a variety of reasons which is nicely summed up by Richard Tomlinson, chief investment officer of Local Pensions Partnership Investments (LPPI), which manages a range of funds across different investment styles and strategies. “While we employ managers that may be classed by some as hedge fund managers, our objective in doing so is to focus on the risk premia and the underlying return drivers of the investment strategy, delivering returns which are independent of mainstream markets,” he says. But some question the validity of hedge funds. FactorResearch founder and chief executive Nicolas Rabener says that the Credit Suisse Equity Market Neutral Index, which evaluates the alpha generation of hedge funds, has returned 0% over the 17 years between its inception in 2004 and 2021. Breaking this down, Rabener presents some interesting analy- sis, noting that markets have become “highly efficient with few arbitrage opportunities left for exploitation”, making the run-
ning of a hedge fund extremely challenging. The ultimate result, says Rabener, is that most hedge funds are in fact providing beta, because alpha is hard to come by due to rising stock valuations. He also asserts that investors are bene- fitting from improved analytics and data, which have enabled them to realize that many hedge fund strategies are “mere beta plays”. So, the focus on low-beta strategies could be timely, offering protection against rising inflation and other volatility-trigger- ing events. “Investors are increasing their allocations to low- beta hedge funds that can achieve high-single-digit returns,” says Marlin Naidoo, global head of capital introduction and consulting at BNP Paribas. On this theme, McGuane offers another perspective. “We are less favourably disposed to strategies exhibiting high and per- sistent beta exposures – long-biased equity or credit – concentrated or highly levered standalone niche strategies – convertible-only, mortgage-only, credit-only, regional or sector-only equity – and concentrated macro strategies, whether discretionary or systematic,” he says. “Strategies that have lower beta to traditional equity and fixed income indices are the favoured type of hedge funds at Callan.”
Year of the hedge fund
The market outlook, with its many unpredictabilities, appears well suited to hedge funds this year, with some investors already turning to the industry to help benefit from – or at least see out – the macroeconomic, monetary and fiscal shifts already taking place that will be the hallmark of 2022. And here there is a hedge fund for every season of uncertainty. “Hedge fund managers are positioning for continued volatility associated with the global pandemic, but are tactically focused on capital preservation across equity, fixed income and com- modity markets, considering the powerful dynamics of rising interest rates and record inflation,” Kenneth Heinz, president of hedge fund analytical company HFR, wrote in a recent hedge fund report. “Managers that have demonstrated the robustness of their strategies over the past two years will likely continue to lead industry performance and growth through the new year,” he adds.
On this note, aggregate hedge fund performance in 2021 was 10.3%, compared with 11.8% in 2020 and 10.5% in 2019 as measured by the HFRI Fund Weighted Composite – tasty num- bers for investors by any measurement. And with one geopolitical worry after another, hedge funds can offer investor protection and then potentially profit from fall- ing asset prices, offering investors a solid bellwether, as events, are inevitably, set to take their toll.
Issue 112 | April 2022 | portfolio institutional | 45
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