Know what to look for when you opt to invest in a hedge fund
For retail investors considering investing in a hedge fund, it’s important to know what to look for.
“Investors who are concerned about elevated levels of volatility going forward or unfavourable equity return prospects should look for hedge fund strategies that have low levels of correlations to general market indices and have proven their ability to protect to the downside during previous periods of heightened volatility,” says Marthinus van der Nest, head of Amplify Investment Partners.
While the past is no guarantee of the future, he says there is still value in analysing how strategies have performed during periods of market stress in the past.
“Investors looking for risk diversifiers and who are willing to leave some returns on the table in favour of offering greater downside protection should consider more conservative long-short strategies,” he suggests.
Fixed income hedge funds, he adds, serve as a great hedge to a traditional long only equity portfolio, as they offer uncorrelated returns and, depending on the strategy, almost equity-like returns.
Investors looking for a return enhancer, on the other hand, should pay close attention to Sharpe and Sortino ratios, in order to ensure they are being adequately rewarded for the risk taken.
VALUABLE INSIGHT
“It’s also a good idea to consider the strategy’s distribution of monthly returns as well as historical drawdowns, which provides valuable insight as to what investors can expect,” says Van der Nest.
As with anything related to investments, the best approach remains a diversified one, he insists. “Just as investors tend to invest in a few balanced funds, investors would greatly benefit from allocating to a few hedge funds, each following a unique, uncorrelated strategy. By blending a few strategies that are uncorrelated with each other, you end up with a portfolio with a much more consistent return profile.
“Furthermore, selecting uncorrelated strategies also allows you to include slightly more aggressive strategies to your hedge fund portfolio without increasing the volatility of the portfolio substantially.”