Home
News
Archives
Classifieds
Events / Conferences
Directories
Subscribe
Resources
FAQs
Contact Us
Advertise In Monitor
Advertising Links

Browse by Topics

A Conversation With
Administration
Alternative Investment
Consultants
Global Custody
Money Managers
Benefits
Compensation
DB Pensions
DC Pensions
Disability Management
EAFE & Emerging Markets
Executive Compensation
Group Insurance
Healthcare
Investment
Legal
Miscellaneous
Pensions
Retirement Planning
Risk Management
Socially Responsible Investment
Technology

Benefits and Pensions Monitor

PDF version

Word document

Hedge Fund Of Funds Offers Great Opportunities

Distressed securities funds seek out companies that are financially troubled – for example, going through a bankruptcy or a financial reorganization. These funds hope to profit from deeply discounted equity or debt securities in the hope that the company will be recapitalized, restructured, or liquidated.

Long/short equity strategies combine long positions with short sales, seeking to profit from insights in both directions while hedging on the overall movement of the market. These strategies may opportunistically tilt their portfolios either long or short, depending on market conditions and the manager’s outlook.

Equity market neutral funds, such as long/short equity funds, take both long and short positions, but neutralize net market exposure by closely matching the size and characteristics of both sides of the portfolio. The idea is to generate returns through stock picking skills (Alpha) and not market direction (Beta).

Macro funds focus on changes to global economies. They tend to make directional, top-down bets on currencies, commodities, and interest rates, along with stocks and bonds, based on how these securities are affected by various economic forces.

Commodity Trading Advisors (CTAs) trade futures contracts on energy, financial indices, metals, commodities, and foreign exchange. These funds are directional and typically based on a systematic, quantitative approach to determine long and short positions in each asset class. CTAs have the potential to profit in both rising and falling markets, enable investors to invest globally, and are typically used to reduce portfolio volatility through diversification.

Short-selling funds take short positions in all their investments. They look for over-valued securities and come into favour when investors sense the beginning of a bearish market cycle. Because losses on short positions can be unlimited, these funds can be very risky.

High Degree Of Risk Selecting one or a few of these individual hedge fund strategies can be complicated and involve a high degree of risk. For these and other reasons, a popular alternative is to invest in a hedge fund of funds. This typically offers expertise and broad diversification, while often opening the doors to a multitude of strategies and opportunities.

A hedge fund of funds may offer numerous advantages over individual hedge funds including:

• Convenience – Rather than perform time-consuming research and due diligence, institutional investors merely need to select a single manager that will select and monitor the performance of a portfolio of hedge funds.
• Expertise – How knowledgeable would a pension fund manager have to be in order to select a diversified portfolio of 20 or more top-performing, responsibly run, and uncorrelated hedge funds? Leaving it to a specialist to source, monitor, and manage a portfolio of talented hedge fund managers makes plenty of sense. It’s also a superior use of limited time and resources.
• Ease of entry – Many hedge funds require a minimum investment of $1 million. So creating a diversified portfolio of 20 hedge fund investments might require an investment of $20 million. For investors seeking a core exposure to hedge fund strategies with an investment of less than $20 million, a hedge fund of funds can be quite effective.
• Diversification – A well-run fund of hedge funds should offer the high potential for absolute returns with far less volatility and less risk of significant loss than a single hedge fund. The key is for the fund of funds to invest in a portfolio of uncorrelated strategies. This should include a variety of investment styles, hedge strategies, and fund managers.
• Consistency – As a result of diversified styles and strategies, a fund of funds should deliver more consistent, predictable returns. There are some drawbacks or challenges involved in a hedge fund of funds investment:
• Risks – It’s worth reiterating that hedge funds use volatile strategies. Even a wellrun hedge fund of funds can’t immunize investors from the inherent volatility of individual strategies.
• Lack of liquidity – Hedge funds are illiquid investments. Unlike mutual funds, they often are not immediately redeemable and may be subject to transferability/resale restrictions.
• Lack of transparency – Unlike traditional registered investments, a fund of hedge funds generally invests in private hedge funds that are not subject to the registration and disclosure of the Securities and Exchange Commission (SEC) in the United States or the Ontario Securities Commission or its provincial counter-parts elsewhere in Canada. This may make it harder to detect fraudulent actions committed by an unscrupulous hedge fund manager.
• Costs – Hedge funds can be costly to begin with, as expenses typically include a management fee of one per cent to two per cent plus a performance fee or commission of 20 per cent of profits. Adding another management fee – and possibly a performance fee – for the hedge fund of funds makes it costlier.
• Overdiversification – If the goal of hedge fund investing is to earn superior absolute returns by tapping into a brilliant manager or strategy, that potential superior performance may be diluted by investing in too broad a mix of funds and strategies.

Do Your Homework

Just as a good hedge fund of funds should perform due diligence and continue to monitor its holdings, there’s no denying the need for institutional investors to do their homework and hold their hedge fund of funds accountable.

Overall, a hedge fund of funds can offer good potential for diversification and superior absolute returns. As with any investment, however, it may be more suitable for some investors than others. Institutions that could benefit greatly from a hedge fund of funds include smaller organizations that don’t have the capital or resources to select and monitor 20 or more hedge funds themselves, those that don’t plan to make a large hedge fund allocation, or institutions that simply prefer outsourcing this specialized function.

Wasyl Saluchok is a vice-president at Northern Trust Global Advisors.

< previous

Home / News Alerts / Archives / Classifieds / Events / Directories / Resources / Subscribe / Login / Contact Us
Advertise In Monitor / Advertising Links / FAQs / People / Privacy Policy / Terms of Service / Sitemap

Copyright ©1999 - 2012 Benefits and Pensions Monitor. All rights reserved.
Pension Fund Investment - Employee Benefits Management