The Power of Hedge Funds in Unpredictable Markets
Financial markets are unpredictable creatures by nature: fickle, stubborn, and susceptible to a number of influencing factors. As global economies and their trading community have become more tightly bound to each other’s fluctuations, this impact can cause both short- and long-term effects that keep investors up at night.
One of the defense mechanisms investment professionals employ to combat unpredictability and instability in financial markets is to recommend portfolio diversification, with a variety of different investment classes and strategies combined to reduce the risks inherent in a highly correlated investment portfolio.
In a 2021 white paper, Investing In Hedge Funds, the consulting giant Mercer stated: It is critical to note that hedge funds are not an asset class. Rather, hedge funds are a collection of heterogeneous investment strategies implemented across asset classes, markets and instruments. At Mercer, we group hedge funds within a category we label “diversifying alternatives.” The label explicitly seeks to encompass the core value proposition itself and the role diversifying alternatives can serve within a portfolio — alternative sources of diversification.
As such diversifiers, hedge funds are one of the best constructs to deliver on this diversification impact. By design, equity-based hedge funds seek to deliver on these characteristics when included in an overall portfolio allocation:
But these objectives are broad and can sit anywhere on a risk tolerance spectrum, from very conservative to highly aggressive. The design of a portfolio and its asset allocation is based upon the investment objective and goals, and as such, the devil is in the details in terms of achieving on these goals. Hedge funds, when included in an asset allocation process, seek to offer both alpha and risk modification to an overall portfolio.
HOW MIGHT A HEDGE FUND WORK TO OFFER THIS ALPHA AND RISK REDUCTION?
Think of a carefully curated and vetted basket of stock selections, both long and short, that have been combined in a portfolio and over time, achieve the twin goals of alpha generation and modified risk exposure while doing so in a manner substantially different from traditional assets classes.
This is the inherent value-add of a hedge fund allocation, and requires a sound investment model that combines focused research and analytics as well as investment management practices that are successful and repeatable over time. In essence, the hedge fund manager is seeking to identify outperformance opportunities on both the short and the long side of the equity spectrum, size these positions appropriately, and continually monitor the hedge fund portfolio in aggregate to ensure that the investment model is on track.
We at Warhawk have built such a fund and look forward to an opportunity to describe how it works in greater detail to you and your team. Please let us know if we can schedule some time to do just that for you.
