Demystifying Hedge Funds

April 2020

Demystifying Hedge Funds

While hedge funds have been around since the 1940s, there is still an air of mystery about them for many investors — and a lot of questions. What do they do? Who may invest in hedge funds? How well do they perform? How do they fit in a portfolio?

Hedge fund strategies are designed to generate meaningful absolute returns across market conditions, with low volatility of returns and low correlations with traditional asset classes. Never intended to outperform in all markets, hedge funds can play an important role in contributing to the risk-adjusted returns of the portfolios of many investors.

The purpose of this paper is to take the mystery out of hedge funds. Specifically, we address:

  • The various hedge fund strategies, their investment processes, how they differ from mutual funds and fees.
  • The case for considering hedge funds in a portfolio.
  • Hedge fund performance over the last decade.
  • Sizing, funding and implementation of a hedge fund strategy.
  • Our outlook for hedge funds.

Diversification remains the time-tested way to deal with uncertainty, and we believe that seasoned investors can benefit by considering hedge fund strategies as part of their portfolios.

Key Takeaways

  • Hedge funds are actively managed private fund structures in which investment managers have latitude to invest in a variety of asset classes. Leverage, derivatives and short positioning are often used as part of the investment strategies.
  • As a general rule, Key Private Bank recommends that qualified purchasers allocate 10% of their portfolio to hedge fund strategies. Since return dispersion across managers is high throughout the industry, the ultimate success of the allocation depends on the quality of the manager selection process.
  • Successful hedge fund investments should be expected to protect capital in down markets and strengthen the overall portfolio’s risk/return profile. When funded from a bond-heavy allocation in today’s low interest rate environment, a diligently sourced hedge fund solution can increase the investment portfolio’s potential.