The Future of Hedge Funds...........Will They Survive?

The Future of Hedge Funds..........Will they survive?

Several years ago I managed money for a small group of Family Office clients.  I was responsible for the entire investment program from asset allocation to portfolio management.  I found myself looking for enhancements to my existing portfolios.  So the search began for diversification benefit and potentially some “Hedge Fund” exposure.  First off, what is a Hedge Fund? 

Hedge Fund Basics

Hedge Funds can be defined in many ways.  There are probably 25 to 30 main styles of funds and it would take far too long to describe each one.  There are countless other “black box” funds in existence that do not fit any conventional classification.  The term Hedge fund has since become synonymous with the “alternative investment” asset class in a client’s asset allocation. 

Hedge Funds are primarily sold to investors as a way to reduce volatility in a portfolio.  The funds often times display a low correlation coefficient which means that they do not move in the same direction as your main asset classes.  In fact, some funds have a negative correlation objective which means that the funds are designed to move in the opposite direction as the main asset classes in a portfolio.

Hedge Funds normally do not have daily liquidity and have somewhat expensive fee structures.  You often times hear Hedge Fund fee structures described as 2 and 20.  This means the fee includes 2% management fee and 20% of the fund profits.  This is pretty hefty when you consider most fee based advisors are in the 1% of assets under management ballpark. 

There would be a lively debate among advisors as to the value of Hedge Funds.  In my case, I never did add Hedge Fund exposure to our portfolios.  The value debate would be especially heated these days where the performance of this broad group has been seen as far below expectations. 

The group has been criticized for high fees and high correlation to the broad market.  I am always puzzled when I hear a Hedge Fund manager speak of good returns in a Bull Market.  If the fund is supposed to be negatively correlated to the broad market then shouldn’t the fund be down when the S&P is having a good year? 

Will Investors begin to move away from Hedge Funds?

I think we are on the edge of an evolution in Portfolio Design.  With the expansion of investment vehicle options, there are now more ways to build portfolios than ever before.  The advent of new portfolio building blocks has given investment managers new ways to not only grow capital, but also provide better downside protection. 

After Q4 2008 – Q1 2009, investors have been nervous about potential systemic market moves.  This has contributed to the strong interest in Hedge Funds and other alternative investments to theoretically protect portfolios in turbulent times.  The search for better downside protection has given way to a new direction in portfolio research. 

Some of this new research reveals the existence of opportunities to give investors better downside protection without Hedge Funds and the negative features they bring to a portfolio.  Better downside protection, lower fees, and liquidity spell trouble for the Hedge Fund industry.

Investment Advisors are continuing to leverage science and math.  We are still looking for better ways to grow and protect capital.  Will our quest to improve upon the 2013 accepted norms of portfolio design lead us to the “flying car” of wealth management?  I think we are well on our way.