bfinance highlights fundamental changes in how allocations to hedge funds should be designed and constructed
bfinance, the independent investment consultancy, has released a new paper on How to Build a Hedge Fund Allocation.
According to bfinance, in a period of heightened uncertainty, in which the pandemic and its macroeconomic implications still loom large, institutional investors are looking towards ‘liquid alternative’ or hedge fund allocations to answer the ongoing challenges presented by low bond yields and highly-priced equity markets.
The new paper highlights that the time seems right for a re-examination of the fundamentals: how should hedge fund allocations be designed and constructed. The paper highlights five key shifts in the last decade:
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Fewer mandates. Over-diversification, with portfolios featuring 50 or more hedge fund managers, was commonplace before the Global Financial Crisis. bfinance now tend to see well-diversified portfolios featuring no more than 10 to 20 managers—or even fewer where the investor wishes to take a more concentrated approach. This trend has also supported demand for multi-strategy, multi-style investment approaches versus narrowly focused styles.
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More tools in the toolbox. Alongside hedge funds, investors now have access to a range of Alternative Risk Premia (ARP) as well as Absolute Return Multi Asset strategies using non-traditional techniques. Within hedge funds we now see a rich universe of UCITS managers and improved availability of segregated accounts in a space that has typically required pooled fund investing. It is important (but sometimes challenging) to consider this broader range of moving parts.
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A rounder approach to diversification. Investors are striking a balance between different goals, with many focusing a little less on Sharpe ratio improvements and more on tail-risk-adjusted performance, convexity amid market crises and the ability to perform during abnormal market conditions. Hedge fund portfolios should not be built in ivory towers of strategic-asset-allocation-type optimisation.
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Controversy around the role of Managed Futures (aka CTAs or Systematic Macro). Some investors and advisors have now essentially abandoned CTAs due to weak performance through an extended equity bull run. However, our own analysis is still supportive of including these strategies in portfolios due to their convex characteristics (i.e. their tendency to deliver positive returns when equity markets fall) and their ability to perform in ‘divergent’ market conditions (when markets are being driven by factors other than fundamentals).
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More demand for high transparency and explicability of returns. Investors increasingly seek return profiles that they can anticipate and understand. Increased preference for lower-cost solutions. Bfinance note ongoing strong competition in the pricing of Fund of Hedge Funds, as well as the rise of innovative structures to improve investor/ manager alignment.
