Opinion: Embrace hedge funds long-term – or leave them alone

Hedge funds are often considered a risky and costly alternative investment choice. And the hedge fund industry continues to grab headlines, very often for the wrong reasons.

Some of this negative focus is justified given the number of performance blow-ups, investor frauds and displays of enormous wealth that have been flagged in recent years. What is less frequently captured in headlines is the strong performance of hedge funds.

For that reason, investment managers from some Asian asset owners have told AsianInvestor that they are looking at hedge funds for tactical asset allocation in the current market upheaval.

"Hedge funds can show extraordinary performance some years, and that makes them attractive. But we need to be very selective,” Kosuke Okimori, managing director at Kewpie Pension Fund, told AsianInvestor in November, for instance.

With equities and fixed income portfolios performing poorly simultaneously, hedge funds could provide a thin sliver of hope to this year’s performance. Needless to say, some asset managers are also rigorously marketing their hedge fund solutions at a time when asset owners are challenged on making the right investment choices.

However, other asset owners are skeptical about hedge funds since the asset type doesn’t complement their long-term strategic asset allocation. The stability of performance and the associated risk remain areas of concerns. The mood seem to be either decidedly pro hedge funds, or still categorically reluctant to invest in the asset type.

This year, the performance has been appealing. According to a paper from WTW (former Willis Towers Watson) released in September, hedge funds had delivered downside protection with returns of -5.6% between January and June 2022 on the HFRI Fund Weighted Composite index compared to broader equity market declines of -20.5% on the MSCI World index.

SOLUTIONS AVAILABLE

In the decade or so after the global financial crisis, equities kept going up, while interest rates were zero or negative. Central banks led by the Federal Reserve provided ample market liquidity, which gained further traction during the Covid-19 pandemic.

This investment environment made beta returns an easy win and hedge funds fell out of favor. That trend persisted despite the HFRI Fund Weighted Composite returning more than 10% each year in 2019, 2020 and 2021, marked by rapidly changing market conditions.

Now, the current environment makes a strong case to invest in them. Investment solutions such as a fund of hedge funds or a hedge fund index could be a way for investors to mitigate some of the diversity and risk concerns that they might have and make an allocation.

Regardless, hedge funds will continue to be on the margins of portfolios for most asset owners. Still, it is worth making a long-term call on this distinct asset type. Either asset owners should consider incorporating it thoroughly and methodically with a long-term view and accept unavoidable fluctuations in performance – or abstain from the asset type and accept the curse of looking back in future and considering that a hedge fund allocation could have provided some performance relief in rough years.