I have been investing in hedge funds for more than 25 years.
Through thick and thin, they have served my long-term
objectives of preserving and growing my capital very well,
especially when conventional markets have been so very
volatile. I am therefore planning to continue to invest in
hedge funds for the next 25 years.
Do I invest all my money in hedge funds? Of course not. But
having a good-sized portion of my assets in alternatives has
served as a very effective diversifier and risk reducer over
Do hedge funds always outperform conventional investments?
Of course not. But historically they have added value. And, to
reiterate my earlier point, I certainly sleep better at night
knowing that I have hedge funds as part of my overall
investment programme, rather than tossing and turning with
worry about the market’s roller-coaster ride.
Many wealthy individuals and family offices have been
disappointed by the performance of hedge funds over the past
five years. Many of these investors recall an earlier time when
hedge funds delivered higher returns. Because hedge funds as a
group have lagged the S&P 500 since the global financial
crisis, private investors are increasingly questioning why they
should bother with hedge funds, or they are voting with their
feet and scaling back their investments.
In contrast, many institutions, including some of the most
savvy pension funds and endowments, actually have been steadily
increasing their allocations to hedge funds over the past five
years, because they understand three important benefits of
• Historically, hedge funds as a group have
outperformed on an absolute or risk-adjusted basis, even after
factoring in their recent results.
• Unlike long-only managers, hedge funds as a group are
• Hedge funds as a group tend to be less correlated
with conventional markets, and thus can help dampen the
volatility of an overall investment programme.
J.P. Morgan’s prime brokerage unit recently
published an in-depth research piece about hedge funds. Its
analysis provides a very clear-eyed view of how hedge funds
have done. To summarise its findings:
• "In the first quarter of 2013... in the aggregate [as
measured by the HFRI Fund Weighted Composite Index] hedge funds
trailed the S&P 500 by 6.74%…"
• "The HFRI Fund Weighted Composite Index…
underperformed the S&P 500 Index by nearly 5% annually from
2010 through 2012. This pattern reflects the run-up in equity
markets as they rebounded from their post-crisis lows, receding
tail risk as the sovereign crisis in Europe eased and gradual
improvements in economic data."
• "Over a longer time period, however, a different
picture emerges. During the 16 years from 1997 through 2012,
hedge funds delivered superior cumulative returns to domestic
and international equities, commodities and fixed income by
HFRI Fund Weighted Composite +225.19%
Barclays Capital US Aggregate Bond Index +161.48%
S&P 500 +92.54%
MSCI AC +68.38%
DJ-UBS Commodity +13.95%"
That wasn’t just any old 16-year period in
which hedge funds outperformed – it was a period
marked by extraordinary market ups and downs, including the
tech bubble, Y2K and, of course, the global financial crisis.
We don’t know what the next 16 years will bring,
or even the next 16 months for that matter. But we do know that
the potential for market dislocations and corrections is ever
present. If you are convinced that markets will go up in a
straight line from here, then long-only investment approaches
are for you. If you appreciate the potential for volatility,
hedge funds can be a useful part of your asset allocation
Consider one more thing. Think back to the depths of the
global financial crisis and the subsequent heights of market
anxiety over Greece, Europe, and the downgrade of US debt. Very
few investors had the stomach to jump into equities at those
points in time. In fact, many were so shaken that they sold at
what proved to be the worst possible time to do so. One
advantage of allocating to hedge funds that are less correlated
is that it becomes easier to ride out the storm.
Throughout my career of investing in hedge funds I have
always sought out what I believe to be the 'all
stars’: seasoned pros who have demonstrated their
ability to add value over time and to avoid the worst of the
market downturns. My team also includes the 'rising
stars’: not amateurs or farm league players, but
well-trained talents who have gained valuable experience at
established firms and have generated strong track records in
their own right. My 'all stars’ and 'rising
stars’ might not be the champions every year, but
their winning record and potential going forward gives me the
confidence to back them season after season.