Wealth Manager - the site for professional investment managers

Register free for our breaking news email alerts with analysis and cutting edge commentary from our award winning team. Registration only takes a minute.

Nick Sketch: why wealth managers got hedge funds so wrong

4 Comments
Nick Sketch: why wealth managers got hedge funds so wrong

A few years ago, many of us invested in hedge funds via funds of hedge funds. The better examples generally offered a better risk-return trade-off than pure equity investment, while offering likely returns ahead of bonds. However, most had some net exposure to equity markets.

Even without the discount swings that many investment trusts in the sector suffered (or the severe problems caused to some by illiquidity in their underlying assets), this feature made funds of this type less than ideal diversifying assets for an equity-based portfolio (and much less good in extreme circumstances than many of us expected).

Critically, many hedge funds claimed to deliver strong returns with modest volatility most of the time, and some delivered just that. For an investor holding hedge funds and cash, this probably means they were good investments. But to a long-term investor with most of a portfolio in equities, what should matter most is how these investments perform when equities do badly.

In short, many investors have done badly in the last five years from their hedge fund investments because the investments did not do a good job, but many others (with hindsight) just bought the wrong hedge fund investments.

The right hedge fund investments

Fortunately, there are hedge funds available in a form suitable for UK investors that did well in 2008, have liquid portfolios, have low expectations of big discount swings (or are open-ended) and have long records of showing low correlation with equity markets – despite often offering returns over many years that compare well with those expected by bond investors or hoped for by equity investors.

This group of hedge funds usually get labelled ‘macro’, ‘CTAs’ or ‘managed futures’. They typically do not hold illiquid assets or individual equity or corporate bond investments, preferring to invest in currencies and interest rates, plus indices of equities, bonds or commodities, typically via ultra-liquid futures markets.

Some leading examples use computer modelling to capture trends (up or down) in markets, while others rely on the skills of individual managers.

Some of these investments are available to retail investors via investment trusts (like those from Brevan Howard and Blue Crest). Others can be bought through a Ucits III structure (eg, Aspect or Standard Life GARS) and a few are offshore funds with UK reporting status (eg, Matrix Ascension Fund, which feeds into Winton Managed Futures Fund).

Many of these funds have long records of high returns (some over 10% a year on average) without excessive risk, plus few bad years, and little correlation with equities or bonds.

To see the real effect of these investments, consider first the actual risk & return behaviour of (say) the FT-Apcims Balanced Index. Now look at what happened over the past (say) five years if an investor allocated 90% of a portfolio to that Apcims index and 10% to Macro/CTA funds like those mentioned above.

Taking the last few years as an initial guide would suggest that adding more in funds of this type sees the volatility in the portfolio’s overall value drop, yet the average annual return rises.

These hedge funds are unlikely to match equities in years when stock markets are very strong, so one should not rely on them adding performance every year to a traditional portfolio, but investments like these really have improved the risk-return balance by offering genuine diversification when investors need it most.

Wasn’t that what we all wanted in such a holding?

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.
Citywire TV
Play Boutique tapes: my business will never be sold

Boutique tapes: my business will never be sold

In the final part of our four part series we discuss consolidation and whether it's getting tougher for boutiques to survive.

Play Boutique tapes: are top managers better off at small firms?

Boutique tapes: are top managers better off at small firms?

In episode three of our series, boutique bosses discuss whether the best fund managers are more likely to thrive at smaller firms.

Play Boutique tapes: if you want a Ferrari, you have to pay for it

Boutique tapes: if you want a Ferrari, you have to pay for it

In the second part of our four-part series, boutique bosses are asked how they can justify the fees charged by active managers.

Read More
Your Business: Cover Star Club

Profile: how this boutique beat the big guns of wealth

Profile: how this boutique beat the big guns of wealth

This small west country offshoot of a local IFA scooped a 2018 Citywire award from beneath the noses of the national challengers

Wealth Manager on Twitter